Target's new strategy pays off in largest sales bump since 2005

Target Corp. is embracing the blur — and it paid off in its best full-year sales growth since 2005.

The blur is the way America shops these days. Sometimes we walk the aisles of a store, sometimes we shop online. We get things shipped to our homes or decide we can't wait that long and drive to the store and pick it up ourselves.

Target now offers at least seven ways to shop, including same-day delivery and curbside pickup — all of it has boosted sales and traffic at its stores and online.

The Minneapolis-based retailer saw comparable store sales grow 5.3 percent during the vital fourth-quarter holiday shopping period, according to fiscal year-end results released on Tuesday.

The broad array of options helped the retailer gain market share in every major category — apparel, home, toys and entertainment, beauty and grocery.

"Our stores-as-hubs strategy isn't putting our core business at risk," Target Chief Operating Officer John Mulligan told a couple hundred investors gathered at an annual meeting in New York City. "It's simply helping us grow faster."

Two years ago, investors weren't so sure. CEO Brian Cornell had stood on the same stage and laid out a three-year plan to spend $7 billion plus $1 billion in annual operating profits to overhaul stores, update supply-chain technology and prepare for the digital age.

Consumers were starting to shop differently, he said, and the company wasn't moving fast enough. Investors sent the stock price tumbling, at a time when Amazon was grabbing market share and retailers were closing stores to invest in digital sales.

On Tuesday, Target stock surged after outperforming expectations, finishing the day at $76 a share, up nearly 5 percent.

"Two years ago, Target was a retailer that stood at a fork in the road," said Neil Saunders of GlobalData Retail. "It chose the difficult path of investment and modernization rather than short-term profit maximization. It is now reaping the rewards and, in our opinion, will continue to do so over the year ahead."

By turning its stores into mini-shipping centers, executives said the retailer was able to fulfill online orders at least a full day faster than when relying on distribution centers, which often are located on the outskirts of population centers.

More than 400 stores have undergone end-to-end transformations, with another 300 on the docket each of the next two years.

The strategy enables the retailer to spend less on freight and other fulfillment costs, averting $2.5 billion in new warehouse costs, according to the company.

Digital sales, which include those from target.com and a mobile shopping app, accounted for about 10 percent of overall sales during the fourth quarter, a boost of 31 percent. Stores fulfilled nearly three-quarters of those orders.

Shipping directly from stores costs 50 percent less on an average unit than shipping from a warehouse. When customers come to the stores to pick up their online orders — the click and collect option — it slashes the cost more.

A relatively new store drive-up option, in which Target employees deliver online purchases directly to shoppers' cars, quickly went from a small pilot project in the Twin Cities to a coast-to-coast option at more than 1,000 stores before the holiday season. Executives said it has been one of the most popular services for consumers and highly profitable for the company.

"The convergence between physical and digital has come full circle," Cornell told investors on Tuesday. "And today, Target is leading the way."

Target's performance seemed to allay concerns that the investment in stores along with a promotional holiday season, rising labor costs and a free, two-day shipping offer might have eroded profit margins.

On the books it came out that way, but Wall Street took it in stride this time.

Net income fell to $799 million, or $1.52 a share in the quarter that ended Feb. 2, compared with $1.99 a year ago, in part because there was an extra week in sales last year.

Adjusting for the calendar and other one-time costs, earnings per share were $1.53, up from $1.36 a year ago and at the high end of Target's forecast.

Executives explained that the sales mix as well as fulfillment costs also contributed to the result. Target made an aggressive play for toys and baby goods to capture sales after Toys 'R' Us and Babies 'R' Us stores closed. Sales of these lower-margin items outpaced those of higher-margin categories, such as home furnishings and beauty.

On the year, Target's reported net earnings of $2.94 billion, or $5.51 a share. Adjusted for the calendar shift, earnings were $5.39, setting an all-time high for the company.

Moody's analyst Charles O'Shea said in a research note that the company's strategic initiatives are "clearly bearing fruit."

"Target continued to build momentum in January, resulting in an exceptional fourth quarter and fiscal year, with margins holding steady despite a heavily-promotional holiday season combined with significant strategic investments across the board," he wrote.

Target's results came amid a busy earnings season for retailers, an industry that's considered a bellwether for consumer confidence and economic resilience.

Kohl's also reported that store traffic was up for the holiday shopping season. Same-store sales were up 1 percent, compared with the anemic 0.3 percent analysts had expected. Costco Wholesale will report on Thursday.

Last week, Best Buy Co. Inc.'s shares rose after it turned in robust results for its holiday season, with comparable sales up 3 percent. Other retailers — including Walmart, Lowe's, Macy's and the parent company of TJ Maxx and Marshalls — also have turned in strong fourth-quarter earnings.

Target's Cornell, along with other retail executives, continues to believe that consumer confidence will remain strong in the year ahead, citing low unemployment and wages that are inching upward.

Looking ahead, Target offered sales growth guidance in the low-to mid-single digit range in the first quarter and earnings of $1.32 to $1.52 per share. On the year, the retailer also expects a low- to mid-single digit bump in same-store sales and earnings of $5.75 to $6.05.