Target Corporation — 2022 Q4

Well, good morning, everyone, and welcome to our 2023 Financial Community Meeting. I'd like to start by welcoming the investors and others who are attending this meeting remotely. And of course, we're happy that so many of you have joined us here in person today.

Well, good morning, and thank you for joining us. Looking forward to spending this time with you. We're eager to share our plans, including how we'll continue to grow, how we'll continue to rebuild profitability on that growth and how we'll strengthen our business in conditions that have changed a lot since we gathered here at the Time Center last year.

Thanks, Brian. Despite the challenges of the past year, Target's differentiated position in retail has never been stronger. With a great assortment, compelling value, an unmatched suite of fulfillment options and a joyful shopping experience, Target continues to drive preference with American shoppers in the face of a turbulent economic and consumer backdrop.

The passion of these designers is so inspiring, the emotion and pride is palpable, and we love the way the Tar-zhay magic of these partnerships cut across categories, including last quarter's launch of Marks & Spencer and Tabitha's recent extension into food.

Thanks, Christina, and good morning, everyone. So Brian talked about the last few years being unpredictable. To put a finer point on that, if you had told me in late 2020, during the height of the pandemic, that 2022 would be the most challenging operating environment in my career, well, I would have assumed you were joking. Yet shifting consumer preferences, supply chain volatility and rising inflation created a set of conditions that called for flexibility, responsiveness and resilience. Our environment remains volatile, and we expect 2023 will have its own unique set of challenges. But if I've learned anything over the past 3 years, it's never underestimate the power of a purpose-driven team and the culture they create.

As you heard from [ Dory ], [ Saad ] and [ Kamau ], we've learned a lot over the past few years, using every opportunity to improve speed, cost and quality. And in regards, our sortation centers are just hitting their stride. We delivered more than 25 million packages through sortation centers last year, and we expect to double that amount in 2023 with the help of our local and national carriers.

Thanks, John. As Brian mentioned, it was exactly a year ago that we were on this stage, talking about our 2021 financial results, a year in which our business generated double-digit growth in comparable sales and even faster growth in EPS. And as Christina discussed, we knew on that day that the environment was likely to change, but we didn't yet know how dramatic those changes would be. The rapid pace of this transition led to multiple profit pressures on our business, including markdowns and other costs related to last year's inventory actions, significantly higher shipping and domestic transportation costs and higher inventory shrink.

Well, Michael, thank you, and Mike, thanks for joining us today. I know everyone would like to get into the work, but I think it would be really helpful to just pause for a second and talk about your background and why we selected you to lead this very important initiative.

Yes. Thanks, Brian. Really happy to be here and excited about the opportunity to lead this work for Target. I've been at Target now for 15-plus years, started in finance, worked in various roles with our merchandising operation partners to help deliver on their strategic priorities and their financial growth. Through that experience, I got to see the business model through the lens of the P&L.

Mike, when you took on this role, we spent a lot of time talking about what this work's about and what it isn't. Can you share a bit about the reasons we've initiated the work and what we're looking to accomplish?

Yes. I think I'll start maybe with what it isn't. This isn't about sacrificing long-term growth for short-term profits. A typical tactic here is to look to shrink your cost base in the face of declining revenues. Well, that's not Target, right? We are growing, continue to grow. In fact, this work has come out from the growth we've seen over the last 3 years. We've grown $30 billion -- over $30 billion since 2019. That's more than 14 years prior. And that creates a tremendous opportunity to step back and reimagine how do we operate this business at a larger scale, but more importantly, how do we position Target for future growth.

Mike, I want to clarify one thing briefly. After Brian and I mentioned this effort in our last earnings call, we got some questions about whether that $2 billion to $3 billion number includes the natural recovery from the headwinds we experienced in 2022. Can you help clarify that?

Sure. I've got a couple of those questions as well. And I would say, I reiterate that this is not about the work over -- or what's happened to us over the last 12 months. It's about the growth that we've seen over the last 3 years. And so no, what's not included is anything that will come, the natural recovery from the headwinds of last year. This work is the designed to deliver fuel beyond that, both to deliver on our -- both our top line and our bottom line goals.

Mike, when we asked you to lead this project, we spent a lot of time thinking about the guardrails. Now obviously, there's big opportunities that we want to capture. But there's also things we never want to compromise. Do you want to talk about the opportunities versus the guardrail of let's say, "We'll never head in this direction?"

Yes, I think that's a really important question. And the things we're not willing to sacrifice start with a team member and the guest experience. We're not going to take away anything given the investments we've made in our team over the last couple of years, and spending that time in human resources during those early days of the pandemic had an appreciation for all our team did to run our business and to serve our guests. And so I look at our team members and the investments we make as an investment in the best team in retail.

Mike, since we first announced this work, I've had a bunch of investors ask me where they should expect to see the results of this work show up in the P&L? Can you share your initial thoughts?

Sure. I think it's -- you're going to see it across the full P&L. So I'm not sure you're going to be isolating it to one single component. What excites me about this work, though, as we think about running the different scale, I think there's top line opportunity. And so it's going to start with sales. Now we're not going to do anything against the -- we're going to continue to invest in our team, but any efficiency work will have SG&A impact on the SG&A line. And product costs continue to be our biggest line item on the P&L, so we'll see it there as well. But I also will say it'll expand beyond the P&L as we look to be more efficient in our CapEx.

So Mike, I know you're still in the early stages of scoping the work, but there's also things that we've been working on for quite some time now that we can build on. Do you want to highlight some of those?

Sure. We touched base on a lot this morning that work around digital fulfillment, I think, is a great example. We've been -- that work in several years underway, when you think about our stores as hub model, has significantly decreased our fulfillment cost. John mentioned 40% over 3 years.

Thanks, Mike. Can you also provide an example of a newer effort you're excited about?

Yes. I think the best example is the work that's underway now in Apparel. This one is near and dear to my heart. My first role at Target was the finance partner for our women's apparel business. I also think it serves as a really great example of what is possible with this work. Apparel, just like the rest of our business, has seen explosive growth. We've grown over $3 billion and now a over $17 billion business in Apparel business. It also has its unique complexities, right, from the fact that we partner with vendors to source raw materials, to the fact that we have unique fixtures in store for presentation. So all the geographical and weather and demographic considerations that go into assortment planning and allocation.

So Mike, I love the way you framed this up. This is all about fueling future growth, driving simplicity, reducing complexity, never compromising the guest experience and the role our teams play. Are there any other components as you think about this, that you want to touch upon?

Well, I'd say thanks for letting me come up to share just a couple of examples. I would say -- I'd reiterate is this starts with growth. It starts about how do we make it simple and easier for our team members to deliver a great experience. And that work is going to be a multiyear journey, and this will require end-to-end problem solving across the value chain. But when we do that, we focus on making a better team member experience. We'll see a better impact to our team, our guests and our P&L.

Well, Mike, I want to thank you for joining us on stage here today. We're really excited about the opportunities that are in front of us. You've heard a few examples today, and we'll continue to provide updates along the way.

Thanks, Brian.

Michael, I'll have you back here in a second.

Great.

So as we get ready to hear from you and take your questions, I thought I'd briefly recap some of the themes you've heard today. First, our commitment to our guests is as strong as ever. Second, our strategy, our multi-category portfolio, our stores as hub model will provide the flexibility we need to keep growing because we're going to stay closely connected to our guests. Finally, there have been some fundamental changes at Target over the last 3 years. We're more than $30 billion bigger. We set the omnichannel standard with stores as hubs. We'll continue to build and innovate in that realm. We'll set the pace in supporting and developing the very best team in retail.

All right. I see hands already going up. We've got paddle runners around the room. As I call on you, I might ask you just to pause, introduce yourself and ask your question. So why don't we start right here. Michael?

It's Michael Lasser from UBS. A few questions. Number one, last year at this meeting, you had talked about an 8% operating margin. So what has changed this year to -- last year to this year structurally with the business to make it a lower operating margin business?

Michael, why don't I ask you to start, and then I'll come back and answer the back half of that question.

Yes. So we've got a journey in front of us on the profit front, and 2023 plays an important role in stepping back to where we expect to get over time. When we guided to a wide range today, even at the low end, we expect over $1 billion in net income growth year-over-year. And we want to execute that plan, that's first and foremost. Under the right set of conditions, we think we can get to 6% in 2024. And then we'll take it from there. But we've got the next couple of years squarely in focus because we've got work to do to recover our performance from last year.

And Michael, back to lessons learned from last year. We've used the term uncertainty quite a bit today. We recognized last year that the consumer trends move very quickly. And one of the things I'm most proud of is the way this leadership team embraced the challenge, took it head on, made the adjustments in our inventory and protected the guest experience. That's why we continue to see traffic growth and unit share gains across our portfolio and why we're so well positioned today for 2023 with overall inventory down 3%, but importantly, discretionary inventory down 13%.

Paul Lejuez, Citigroup. A couple of questions on Drive-Up returns. Curious what percent of your returns are done at store? Also what is your typical attach rate? When you get somebody in a store that would return an item, do you also convert them to sales? Is there a risk that you might give up that opportunity? And then second, just high level, free cash flow. Once you get through all the working capital changes in F '23, what does free cash flow look like in your view for this upcoming year?

All right. So several questions to answer there. John, I might ask you to start and explain why we're so excited about the changes we're making with returns through Drive-Up. And then Michael, we can talk about the second part of the question.

Yes. The majority of returns come back to store, but a meaningful portion are still shipped back to us. So that's not insignificant. As it relates to your -- the second part of your question around attach rate, and this is the question when we started Order Pick Up and when we started Drive-Up. And to us, that's respectfully not an important consideration.

Yes. John, I think one of the things we've learned over the last 3 years, and we watched it carefully as we expanded Drive-Up and Pick Up and started delivering right to your home with Shipt, we said, all right, is this going to impact the guest engagement in store? It's quite the opposite. As guests use all of our capabilities, they actually spend more dollars in-store and just reward us with more trips. So it's been an important learning that we'll build on. And I think we'll just deepen that engagement as we give them another easy solution for returns.

Yes. Just -- at risk of piling on. We care about economics at the transaction level. We care about the economics at the category level. We care about the economics at the fulfillment path. But the thing that we thought differently about over time is cutting the economics by guests. When we take friction out of the process and make it easier for guests to just fall more and more in love with Target, that's the most powerful economic relationship to be focused on. I think we've learned that time and time again, and Drive-Up is a perfect example.

I think I see a hand up right in this first row. In fact, quite a few. We'll start right in the middle.

Simeon Gutman, Morgan Stanley. You mentioned that fulfillment costs, I think, on digital are down 40% since 2019. Is there any merit to the fact that you're a $110 billion sales organization and that you've suddenly become less efficient such that this path back to 6% requires investments? And so the ultimate question is how much of getting back is the pure recapture of lapping markdowns, freight costs, shrink versus how much you have to invest to get back to that level?

Yes, I'm happy to start. It's a piece of both. We've seen some structural changes in the business. We talked about shrink as being one, and that's not one that we expect to turn in a different direction quickly. But the efficiency we've been able to drive, given how efficient stores are as a fulfillment hub is a huge advantage to us when it comes to digital fulfillment. It's fast for the guest, the economics of it work for us and we build engagement like we talked about before.

Sorry, Brian. I'd add on as it relates to capacity, particularly because you brought up fulfillment, we've seen our sales productivity in the store increase by 37% over the last 3 years, Brian mentioned that. We still have -- so an average store has gone, call it from $40 million to $55 million over the last 3 years. We still have stores that do over $100 million and do well over $100 million. The top quartile does significantly more than the median store.

Why don't we go in the back?

Okay. Christina, do you want to talk about what we're seeing as far as guest shopping behavior?

Yes, happy to. First of all, over the last couple of years, we've gained a tremendous amount of new guests into the Target ecosystem. And so our focus right now has been to deepen our engagement with the guests. Of course, we always want more guests, but the opportunity in front of us is much more to convert them into using the suite of capabilities because they become much more loyal. They understand the Target value proposition more deeply once they experience the ease and convenience of Drive-Up or once they recognized what an incredible food and beverage offering we have. And so that's our primary focus right now.

Right. Moving right here.

Right. Maybe I'll just -- I'll jump in. Greg Melich. I got the mic. I'll just do it.

You got the mic. The power of the mic, Greg.

Really two questions. John, maybe -- well, maybe, Michael, if you could help us on some of the other margin drivers that you see, particularly shrink, you called out is still a headwind. What do you do to actually fix that? I'm also thinking credit profitability now that some of the delinquency rates and other charges are changing.

Michael, why don't I start with the focus on traffic. And as we sit here today, and you've heard me talk about this for years and years now, we think one of the most important indicator of a retailer's health is the traffic indicator. And that's why we feel so good about the fact that we've had 23 consecutive quarters where we've seen comp store sales growth, and it's all on the back of traffic. We're getting more footsteps into our stores, more visits to our site, greater engagement. Our guests are spending more with us. They are rewarding us with more trips and they're shopping more categories. And we think that's critically important.

And maybe for the second part of your question, Greg, when it comes to margin and profitability in general, it starts with what Brian did. The strength of the top line is going to matter a lot and we feel encouraged by the traffic trends that we've seen.

Okay. Why don't we go back there.

Ivan Feinseth, Tigress Financial Partners. I have two questions. Could you go into some detail on how Roundel contributes to revenue growth? What percentage of your vendors are on it? And how you demonstrate your value proposition to them?

Right. Well, Christina, I'll let you talk a bit about Roundel and just how important it's been for our vendor partners and deepening engagement. But the second question is something we talk about all the time. And sitting here today, you and I both know, while we have built great momentum and added over $30 billion of growth, we know we still have category opportunities all around us.

Yes. So first, Roundel, like I mentioned in my prepared remarks, is an incredibly important part of our ecosystem. It gives our vendors an opportunity to target the guests that they see as most likely to be intrigued by their new products and the quality of merchandise that they're bringing to market. It allows us to highlight those products and give them real-time insights about how it's selling because of the closed loop reporting that we can offer.

Yes. I want to go back to the heart of your question. Do we have opportunities to continue to grow share? And it's something that Michael and I talked to many of you about all the time. Despite the growth we've seen over the last few years, adding well over $30 billion of top line growth, sitting here today, we represent 3% of the retail market. So as a leadership team, we see opportunities to grow across our entire multi-category portfolio, continue to leverage growth in store and from a digital standpoint.

Ed Yruma from Piper Sandler. It sounds like Beauty has been a real strong category for you. Can you click down a little bit more on Ulta, maybe the difference in performance there versus non-Ulta stores? And maybe why not move faster? And then just as a quick follow-up on the $2 billion to $3 billion in efficiency gains, do you have any of that baked into '23?

Christina, you want to start and talk about Beauty? And then Michael, we can talk about '23.

Yes. First and foremost, Beauty at Target has been a success story for a number of years. We have an incredible assortment that's been relevant for a while. But adding Ulta Beauty has completed our assortment. Our ability to offer prestige products in our store with a servicing experience and expertise that Ulta has brought to the table has been the missing link. And so we've completed that picture.

Yes. Ed, you and I actually walked a store recently. And I think you heard from our local team, the fact that very excited about the results we're seeing with Ulta Beauty and it's clearly driving even more traffic to Target. But at the same time, that team talked to you about the fact that our core beauty assortment continues to grow. So they're complementing each other, and we're just becoming more and more destination for that beauty shopper.

On the $2 billion to $3 billion, there's a piece of that, that shows up in 2023. But a large chunk of that is multiyear in nature. And you think about the apparel example that Mike shared, I think that's just a perfect example. That's a business that grew so fast over the last few years and our teams did an amazing job to protect the good guest experience as we grew.

Great. Let's go to this paddle right here.

Chris Horvers, JPMorgan. So my first question is you sit at these apex of different general merchandise categories that were major COVID winners. So as you peel away and look at the unit trends that you saw in the fourth quarter, are there signs of any stability, whether it's TVs or computing or decorative home or athleisure? Is there anything that has given you some encouragement to say like maybe we're getting to the bottom of the curve?

Christina, you want to unpack some of the trends we're seeing in discretionary categories?

Yes. The most consistent theme is where there's innovation, there's still relevance. And so consumers are finding them. Social media, of course, is a great way for consumers to become connected to new products and new ideas, and you'll be surprised things will spike quickly.

Chris, if we go back to discretionary categories. You heard us talk today, Christina highlighted the fact that in 2022, despite some of the softening trends, we still generated $55 billion of revenue in discretionary categories. One of the things I highlighted this morning during my CNBC interview is I go back to 2019. We've grown our discretionary portfolio by almost $14 billion.

Yes. I think we're both at, what, 20 years or so at Target, Christina? We've seen ebbs and flows across the categories in our assortment over that time. And to us, the long-term winners will be the ones that build engagement in the moment now. That's why we're so focused on traffic. Apparel and Home will have their time in the sun again, and we'll be well positioned when they do.

I'm trying to scan through the room to see hands that have been up for a while that we haven't gotten to. Let's come back over here.

Karen Short from Credit Suisse. So a couple of questions I wanted to ask. We know what your tail -- or headwinds were for '22 in terms of dollars. You're at kind of the $1 billion-plus mark. And obviously, we know what you're guiding to on operating profit dollars for this year.

Yes. It's a good question, Karen. And I guess I'd go back to just kind of philosophically how we think about the business. We're in the maximizing dollars business. And so we'd read and react through this year to make the right choices that we think maximize profit dollars both for 2023 and position us well for beyond.

All right. Looks like we've got time for one more question. I see a paddle up in the back.

Great. Pressure is on here. Peter Benedict at Baird. I guess first question would be on gross margin, down a little more than 500 basis points since 2019. Assuming mix doesn't get any better the next couple of years, just curious, Michael, how you think about the recapture of a portion of that? Where are the opportunities there? What would you think? Again, without mix getting dramatically better.

Yes. Maybe I'll do those in reverse. The wide range of guidance that we gave today is reflective of the scenarios that we envision right now. And so we feel good about the line we've drawn in the sand with that guidance now and we'll get a lot smarter together as the year plays out.

Right. So with that, I want to thank all of you for joining us today. I know we'll see many of you throughout the year, and I hope to see all of you back here at the Time Center next year. So thanks for joining us. Get home safe.