Target and Walmart building inventories for different reasons

This is an excerpt from Thursday’s (5/20) Point of Sale retail supply chain newsletter sponsored by ArcBest.

Target welcomes margin compression if it means fewer empty shelves

Chart: Andrew Cox/FreightWaves; Data: Company earnings releases

On Wednesday, Target reported monster first-quarter results, handily beating Wall Street expectations on the top and bottom lines. In the first three months of the year, comparable sales grew 23%. This is remarkable given that the quarter was lapping a big 10.8% comp last year.

Target has now posted four consecutive quarters of 20+% comps, which is exceptional.

The numbers:

Total comp. sales +23% yoy
Store comp. +18% yoy
Digital sales +50% yoy
Gross margin 30%, +490 bps yoy
All-time high EPS of $3.69 vs. $2.02 consensus

The takeaways.

Store traffic rebounding faster than competitors. Target has seen an enthusiastic return to in-store shopping earlier than its rival Walmart or competition from department stores and other off-mall retail. Target’s comparable store sales (a key metric that tracks sales at stores open at least 13 months) rose 18% in Q1, “driven almost entirely by higher traffic and accounting for the vast majority of our growth,” according to CEO Brian Cornell.

Chart: Placer.ai

Target has experienced foot traffic growth compared to 2019 in three of the first four months of the year, with the only exception being in February, when much of the country was hit with severe winter weather. But the return to stores hasn’t derailed Target’s rapid e-commerce acceleration, which grew 50% yoy. Indeed, Target’s e-commerce sales growth slowed considerably, but from the torrid triple-digit rate it’s posted throughout the pandemic.

Same-day services continue to flourish. The same-day services that consumers flocked to for safety during the pandemic have remained highly sought after for their convenience. Sales through same-day services rose more than 90% in the three-month period, led by 123% growth of Drive-Up sales. In-store pickup sales rose 52%, while sales through Shipt gained 86%. Target has believed same-day services would be a big hit with its customers for some time, but even management has been surprised by the growth. Drive-Up, Target’s well-oiled curbside pickup machine, has seen sales volumes grow through the service 21x over the past two years. Target is now fulfilling two-thirds of online orders and more than 95% of sales from its stores.

Because of its same-day service penetration, and a keen focus on every aspect within its stores, Target has created advantaged unit economics vs. its competitors. While its competitors have seen supply chain and digital fulfillment costs outpace sales, Target, by removing the packaging and parcel/final-mile delivery costs, has seen stable supply chain costs compared to last year.

Target is continuing to invest in its same-day operations, with plans to optimize the front ends of more than 100 locations this year to free up additional capacity for same-day growth. The company will add refrigeration and freezer space to expand the product assortment available for pickup while making the layout safer and more efficient for employees. Also, Target recently announced adult beverages will be available for pickup and Drive-Up in more than 1,200 stores and available for same-day delivery via Shipt in more than 600 stores across the country.

Target wants to avoid leaving sales on the table again. Despite significant supply chain challenges, Target was able to grow inventories substantially over this time last year. Management was able to match inventory growth to sales growth, with each rising roughly 23% yoy. CFO Michael Fiddelke said the company “feels really good about our inventory position heading into the second quarter.”

However, when looking back on 2020, he stated, “We were sold through in a lot of seasons last year, and that’s not optimal for us.” As I wrote back in November, by prioritizing the fastest-moving SKUs, retailers (Target included) purposefully left other shelves empty in the back half of the year. And after leaving sales on the table last year, Target doesn’t want to see empty shelves at the end of a season set in 2021. The trade-off means more promotions and clearance markdowns, but Fiddelke said, “I would welcome a little bit of that rate drag because it means that we’re full and in stock for the guests throughout the season.”

TL;DR — Target posted another incredible quarter as investments in exclusive brands, supply chain and fulfillment services strengthened customer loyalty and kept them coming back. Foot traffic is returning in a major way, with growth vs. 2019 in three of the first four months of the year. While demand for durable goods remains strong, Americans have shifted to buying more items tied to reopening, including apparel, luggage and cosmetics. Target was able to grow inventories in Q1 and plans to continue building inventories as it seeks to avoid the empty shelves of yesteryear.

Walmart is building inventories, doubling down on price amid rising CPG costs

Walmart handily beat consensus expectations when it reported its first-quarter results this week. The company said it too is seeing accelerating traffic to stores, especially for groceries, where President and CEO Doug McMillon said the company gained market share. John Furner, president and CEO of Walmart U.S., said the company is focused on its principle of everyday low prices after a year when rollbacks were limited. In the first quarter, Walmart grew gross profit margin 96 bps while also having “30% more rollbacks in stores” vs. last year, according to Furner.

The numbers:

Total comp. sales +6%
U.S. e-commerce sales +37%
Sam’s Club comp. sales +7.2%; e-commerce +47%
EPS (adj): $1.69 vs. $1.21 consensus

The takeaways.

Strong e-commerce growth amid customers returning to typical patterns. Walmart posted 37% online sales growth, even as customers returned to stores and returned to normal shopping patterns. During the pandemic, both Target and Walmart benefited from the rise of “mission-driven shopping,” a trend that pushed shoppers to spend more time in fewer locations. The result was an increased visit duration that drove larger basket sizes and privileged the type of one-stop-shop experience that Walmart and Target were built to satisfy. According to Ethan Chernofsky, VP of marketing at Placer.ai, as the duration has declined back to normal, both retailers are simply seeing the behavior shift with visitors making more, albeit shorter, visits to compensate.

On Great Quarter, Guys this week, Chernofsky said one of his biggest takeaways from the past few months has been that “behavior didn’t change in a really extended period.” Placer.ai’s data is indicating that behaviors are returning incredibly quickly in regions where COVID limitations have been lifted.

Inventory growth outpacing sales growth as Walmart looks to double down on price. Walmart’s U.S. store sales grew 6% in the quarter, but inventory rose 16%, in part due to the lapping of last year’s COVID-related effects on inventory. The company said it continues to monitor supply chain challenges related to transit time and port delays, but said its merchants have taken steps to mitigate, including extending lead times for orders.

During the first several months of the pandemic, retailers, particularly grocery shops, largely shelved discounts as they struggled to keep up with demand. Rather than low prices to encourage customers to buy multiples, Walmart and others were restricting purchases of hot items like toilet paper and chicken breasts.

Lately, grocery retailers have been faced with a new challenge: widespread price hikes from CPG companies like Coca-Cola, P&G and others as commodity prices rise. But Walmart is holding the promotional line and is doubling down on its key competitive advantage. In Q1, Walmart rolled out 30% more discounts than it did in Q1 of last year, but a beneficial mix shift helped boost margins. Furner said important shifts are happening not just in the entire box but also the mix within food to higher-margin goods like meat and produce and bakery.

Walmart’s high-margin, fast-growing alternative revenue streams such as its advertisement business and third-party marketplace give it additional flexibility on price without sacrificing profit.

McMillon recounted a memorable lesson from his time as an assistant food buyer at Walmart that perfectly symbolizes the current environment.

“My supervisor walked into the room with a few of us and said, ‘We’re short on our profit number for the month. I need you all to find price reductions that you can put in place quickly. Bring them to me by the end of the day.’ And I thought I misheard him,” he said. “How do you lower prices and increase profit?”

He later came to understand, “That’s the beauty of retail,” he said. Walmart, now with considerable e-commerce penetration and capabilities, paired with Walmart+, Walmart Connect and marketplace, has many levers to “be able to find places to go upstream [and] do things differently than other people are doing it,” McMillon said.

TL;DR — Walmart continues to grow above expectations and isn’t getting complacent. The company is in the midst of nearly a dozen technology pilots, ranging from autonomous middle-mile runs to drone deliveries and electric final-mile vans. Like Target, the company is expecting more promotional activity throughout the year, despite the supply chain challenges. But, Walmart executives see rollbacks as an opportunity to boost profits, while Target plans to trade margin compression for fuller shelves.

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