Target CEO: $7 billion investment in stores and technology is paying off

It was the equivalent of standing on stage and being pummeled with tomatoes.

That's how investors reacted two years ago when Target Corp. Chief Executive Brian Cornell stood before them in a cavernous New York City ballroom and unveiled a three-year plan. The company would spend $7 billion in capital and $1 billion a year in operating costs to modernize operations for the digital age — with most money going toward store remodels.

"I had people shaking their heads," Cornell said this week. "You could see it."

A stunned Wall Street dealt Target its worst one-day decline in nine years that day. It took 10 months for the stock price to recover lost ground.

On Tuesday, Cornell will be back on the same Park Avenue stage to deliver fourth-quarter and fiscal-year earnings, along with a progress report on the multibillion-dollar investments he hopes will be better received.

On the heels of a 5.7 percent boost in comparable sales during the November-December holiday shopping period, the Minneapolis-based retailer is poised to deliver its best fourth-quarter finish since 2005.

"Today we're in a very different position because those investments are paying back in a really meaningful way," Cornell said in an interview at the company's downtown headquarters.

The focus in year three of the effort will be on maintaining momentum, scaling up successful efforts and demonstrating the durability of the strategy, he said.

In the past two years, Target has spent about two thirds of that $7 billion spiffing up shopping aisles at more than 400 locations and creating backroom shipping and packaging centers to get merchandise to customers at warp speed for little or no cost.

The company upgraded its website and digital shopping apps and sunk money into supply-chain logistics. It has launched nearly two dozen private labels in apparel and home decor to restore much-needed fashion panache to the brand.

But market-share gains have come at the expense of profits, and investors haven't always been patient.

Shares tumbled 10 percent after Target reported a decline in third-quarter profit margins in November.

"There's a lot of complexity and costs associated with doing some of these services," said Steve Dennis, a former Neiman Marcus executive and owner of the strategic-advisory firm SageBerry Consulting in Dallas. "They deserve credit for fixing some areas where they were weak and stepping on the gas. Whether they'll be able to sustain it, time will tell."

Target is playing catch-up to Walmart and Best Buy in its ship-from-store efforts, but some latecomers are gaining ground. Department stores, including Macy's, Nordstrom and Kohl's are making rapid inroads in e-commerce. Those that have been slower to seize market opportunities have found it impossible to compete, and Target has picked up some of their business. This week, J.C. Penney, Gap, Victoria's Secret and Foot Locker announced a combined 465 store closings after poor holiday earnings. And Sears declared bankruptcy and liquidated 225 stores at the end of 2018.

Amazon, meanwhile, is losing money on its Prime delivery service to gain market share, sinking more money into fulfillment centers and learning how to leverage its Whole Foods brick-and-mortar locations.

"How much of this is defensive vs. offensive?" Dennis wondered about Target's investments. "There are a lot of things you have to do just to compete effectively with Walmart, Costco and Amazon."

Cornell's goal is to make Target "America's easiest place to shop." That means providing a dizzying array of choices for finicky consumers who can shop anywhere in the world with the click of a mouse or tap of a finger.

There's same-day delivery service with a $99 subscription to Shipt, a company Target purchased for $550 million in December 2017. There's the $2.99 next-day delivery service for bulky essentials, such as laundry detergent. Customers in urban areas such as New York and Boston can pay $7 to have items brought to their homes. Then there's free in-store pick up and curbside delivery along with two-day shipping on most items.

"They've been very successful on the delivery front," said retail analyst Ken Perkins of Retail Metrics. "That's where a lot of the business is headed. The holy grail is one-hour, same-day delivery. Their investment will be a major advantage for them relative to other competitors."

Target has quickly ramped up the scale of options to gain market share. Shipt shoppers now gather up groceries and other items for consumers in more than 80 percent of Target stores.

Busy urbanites readily pay a premium for convenience. They spend five times more than the average Target basket and tend to buy high-margin goods such as home furnishings.

This year, Target plans to open small-format stores in Los Angeles and Washington, D.C. It also will move near more college campuses as well as upscale tourist sites, such as Cape Cod, Mass., and Santa Barbara, Calif.

Analysts are heartened at the gains in market share and store traffic, but some remain wary about the costs it takes to deliver on the instant gratification needs consumers have come to expect.

Moody's analyst Charles O'Shea is uneasy, fearing that the payoff may prove elusive as retailers enter an "arms race" over delivery services.

"While these efforts are certainly beneficial to the consumer, a broader question looms: How much is too much?" he noted in an in-depth dive on retailers' strategy. "It is unclear how much of the ultimate cost of same day-delivery customers will be willing to 'subsidize,' " he said.

For the holidays, Target absorbed shipping and freight costs to offer free two-day shipping on any order. It hired more temporary workers than any other retailer — 120,000 — and was determined to match prices to stay competitive.

Analysts will be keen to see what effect labor and shipping costs as well as recent tariffs on Chinese-made imports will have on the bottom line.

Target points to efficiencies gained in turning its stores into hubs, and the popularity of services.

In-store pickup and curbside delivery costs 90 percent less on average than fulfilling from a warehouse.

Drive-up delivery is the fastest and most popular of the options, Target executives say. What started out as a 50-store pilot in the Twin Cities area in October 2017 now is in 1,000 stores.

Shipping from stores that are just miles from shoppers' doorsteps enables swifter delivery that is 50 percent less expensive than shipping from a distribution center, the company says.

Heading into Tuesday's meeting, Cornell is quick to temper expectations that the multiyear effort is on the home stretch.

"The reason we're doing this is not to move the needle for the next three years," Cornell said. "Back then, we said we were going to play the long game and make the right investments to ensure that this is a viable and thriving business, and that the Target brand is one of the winners in retail. It won't stop in 2020. We've got a lot more work to do."