Target’s stores focus on convenient one-stop shopping and competitive discount prices, offering a broad range of products including beauty & household essentials (24% of sales), food & beverage (20%), apparel & accessories (20%), home furnishings & decor (19%), and hardlines (furniture, appliances, etc. — 17% of sales).
Rivals and new entrants also have to compete with the massive distribution network and supply chain that Target has built over the years. The company has long-lasting relationships with suppliers that often span decades and has invested heavily in logistics to keep its shelves stocked in a timely manner with relevant products.
Nevertheless, retail is a highly competitive industry that's undergoing a major transformation, and Target is hardly immune to the changes taking place.
In 2017 management outlined a three-year, $7 billion plan to make Target more competitive in the wake of e-commerce. The most important part of management's strategy is its "omnichannel" initiatives that integrate online and in-store shopping to maximize convenience and keep shoppers from choosing Amazon or Walmart.
For example, by utilizing its 1,800 locations as pickup centers, Target is able to offer same-day fulfillment on many orders placed online. The company has also partnered with Shipt to offer home delivery on thousands of grocery and other items. In a few clicks, busy people can have way they need without spending time in the checkout line.
At the same time, Target is continuing to invest it its in-store shopping experience by remodeling over 1,200 of its stores. Between 2015 and 2018, the firm's spending on store improvements nearly tripled from $550 million to over $1.6 billion. These projects create a more modern, upscale look at stores that drives incremental traffic and sales growth.
Essentially, Target has shifted from a strategy based on expanding its store count quickly to one that seeks to maximize same-store sales growth created by a more efficient and premium shopping experience both online and in its brick-and-mortar locations.
Traditionally, retailers have grown by opening new stores and increasing sales at existing stores. But in the age of Amazon, it's hard to argue that America needs more big-box retailers, especially as suburbs are already filled with Walmarts, Targets, and the like.
It's no surprise then that Target is opening fewer stores than ever before. And those that Target is opening are smaller urban stores with less revenue potential.
In other words, Target's growth going forward will need to be driven by an increase in sales at existing locations, which management says will be led by its omnichannel investments integrating online and in-store shopping.
However, at this point, Target's investments into e-commerce are simply table stakes to compete in a world where Amazon can deliver millions of items in as short as an hour. Target is merely doing what all retailers must do to survive, so it's hard to say whether these investments will ultimately earn a satisfactory return.
Moreover, due to the high costs of building distribution centers and the ease of comparing prices online, internet retail is a notoriously low-margin business made profitable only through sheer volume. Yet Target is far from a market leader with just $5 billion in online sales, well behind Amazon ($60 billion) and Walmart ($20 billion).
In fact, Target's operating margin, which measures how much profit the company earns for each dollar of sales, has taken a hit since the company began investing in digital:
It's also worth mentioning that Target's sales are somewhat cyclical. While Target stores do sell grocery items that are mostly non-discretionary in nature, groceries make up only 20% of sales. Walmart, for comparison, generates more than half of sales from groceries.
As a result, Target's sales slid 5.5% during the last recession, while Walmart same-store sales actually grew 1.6% and 2.5% in 2008 and 2009, respectively.
The bottom line is that Target's earnings, and therefore its dividend, are likely to grow more slowly than in the past. While Target has historically grown its dividend more than 10% per year on average, management's most recent dividend hike came in at just 3%, reflecting the company's slower growth prospects and need to invest heavily.