Target Corporation — 2023 Q1
Transcript
Each turn shows the speaker, their inferred role, the section, and that turn's net sentiment (×1000).
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation First Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, May 17, 2023.
Good morning, everyone, and thank you for joining us on our first quarter 2023 earnings conference call. On the line with me today are Brian Cornell, Chair and Chief Executive Officer; Christina Hennington, Chief Growth Officer; John Mulligan, Chief Operating Officer; and Michael Fiddelke, Chief Financial Officer. In a few minutes, Brian, Christina, John and Michael will provide their perspective on our first quarter performance, along with our outlook and priorities for the second quarter and beyond. Following their remarks, we'll open the phone lines for a question-and-answer session. This morning, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Michael and I will be available to answer your follow-up questions.
Thanks, John, and good morning, everyone. In the first quarter, our team's discipline and dedication to staying in step with our guests, drove results that met or exceeded the expectations we set at our financial community meeting back in February. Q1 total sales increased 0.5%, reflecting flat comparable sales at the midpoint of our guidance range, combined with the benefit of sales in new locations.
Thanks, Brian, and good morning, everyone. In many ways, the themes of the first quarter operating environment were very similar to what we've outlined in recent quarters. So it likely comes as no surprise that we continue to face elevated volatility and see a reprioritization of spending away from discretionary categories in the face of persistent inflation in groceries and essentials. Despite the near-term challenges facing the retail industry and our business, we remain confident in our ability to generate long-term results, largely driven by the unwavering commitment displayed by the Target team, to our guests, each other and the communities where we operate. Guests continue to place their trust in Target, choosing to shop with us more and more often, at a time when consumers are hyper-focused on managing their budget.
Thanks, Christina. Through all of the rapid and unexpected changes we've experienced over the last 3 years, teams throughout our operations have done an amazing job, maintaining their energy, staying agile and doing everything in their power to serve our guests' ever-changing needs. And today, with 2 years of unusually rapid growth behind us and last year's excess inventory in the rearview mirror, we are focusing this year on training and development for our team with an emphasis firmly centered on retail fundamentals. Our goal is to reinforce the reliability and consistency of our shopping experience as we help our team members to succeed in their current job and build the right skills to prepare for the next one.
Thanks, John. In many ways, the environment today feels completely different than 3 years ago when the pandemic was just beginning and no one knew what to expect, but today even as the pandemic feels further and further behind us, we continue to face elevated macro uncertainty and volatility as the world continues to transition toward a new normal. From a macro perspective, inflation remains high and stubbornly persistent, having recently peaked at decades high levels. To control this inflation, the Federal Reserve has been raising interest rates at an unprecedented pace. But for now, despite the building economic pressure from both inflation and higher interest rates, the U.S. unemployment rate is lower today than it's been in 50 years. And as Christina mentioned, consumer spending patterns continue to evolve, putting significant pressure on our discretionary categories.
As Michael just mentioned, we don't build our strategy based on a single moment, but focus on the best way to serve our guests over time. We take that approach when we invest in our stores, in our supply chain, in digital fulfillment and our team. And as we've said many times, we also build our assortment to serve the long-term needs of our guests and the benefit of this flexible assortment strategy has been clearly evident over the last few years. Following the onset of the pandemic, we saw unprecedented traffic and sales growth in our discretionary categories.
[Operator Instructions] Our first question comes from Ed Kelly with Wells Fargo.
I wanted to start with the guidance. I mean, clearly, you're beginning to see increased consumer pressure now in Q2. And I think those signs of weakening are broad out there. But the midpoint of your guidance implies a pretty good back half improvement. I'm just kind of curious how you thought about Q2 with the reaffirmation of the full year? And is it realistic for us to think that the back half would be in the low $2 range, given what Q2 guidance is?
I'll let Michael start by talking about Q2, and then I'll talk about our focus on the balance of the year.
Yes, thanks for the question. You said part of the answer right in your question. We continue to take a cautious approach to the top line. We think that served us really well in the first quarter. 1 of the reasons we got the profit outcome we did in the first quarter is that with inventory position conservatively, that gives us flexibility and agility. And so you'll continue to see us take that posture for the balance of the year. And that comes with an impact on the top line and the bottom line. Our leverage looks different at a slightly negative comp than it does when we're running a positive comp.
You heard Christina talk about the changes we've taken from an inventory standpoint, the benefits that it's going to provide over the balance of the year, that gives us optimism as we think about the full year guidance. The combination of reduced inventory allows us to bring newness into our assortment, make sure we're on trend with the items we know our guests are shopping for, continue to leverage the traffic gains we've seen now for 12 consecutive quarters and balance the strength we're seeing in Food & Beverage, Household Essentials and Beauty with the seasonal moments where Target shines. So as we sit here today, we're excited about Back-to-School and Back-to-College. We've got great plans for the holiday season. And Christina and her team have done a fabulous job of making sure we've got new on-trend items that are going to delight our guests and provide that affordable joy we're looking for each and every day.
Just a follow-up. At the Investor Day, you mentioned that 6% is, I guess, potential for '24. And the backdrop is shifting though. Can you just sort of update us on your thoughts around that building blocks considering the macro?
Yes, nothing new to share on that front today. I mean, as we sit here 1 quarter into the year with a comp that played out kind of exactly as we expected and a full year guidance that we think is still appropriate. I think we're -- the underlying work in front of us to build back profitability, a meaningful piece of which is part of our plan here in 2023. It will be the first step along that path.
Our next question is from Chris Horvers with JPMorgan.
So a follow-up to the first question there. So on the comp side, is it your expectation that despite disinflation in consumables that clean inventory, some new newness and easier compares, you're expecting general merchandise performance to, I guess, maybe get less worse as we get into the back half of the year?
Chris, maybe I can start this one. We acknowledge that there's a lot of volatility and that we cannot predict the future, but our expectation is that some of the strengths of Target really amplified during the back half of the year. And it starts with what Brian said, Back-to-School, Back-to-College, where the full value proposition of Target is really put on display. You can leverage all 5 categories in our multi-category portfolio to achieve what you need for your families, buying backpacks and lunches and new outfits for school. And that really then sets up into a cadence of the fall with -- we start new fashion trends in September. We go into October with Halloween, followed by Thanksgiving and Christmas, and those are big moments for Target.
Chris, the only thing that I might add to that is, that's all underpinned by a clean inventory position. I mean 1 of the benefits of planning inventory cautiously as we've got the flexibility to lean in to all the good stuff Christina just talked about. And so the end of the quarter, down 16% on a year-over-year basis, that's over 25% in the discretionary categories gives us a lot of room to maneuver as we get into the back part of the year.
Got it. Then as a follow-up, just thinking about the puts and takes as you move through in the back half of the year on the margin, particularly on the gross margin front. So it sounds like the shrink kind of wait and it sort of dissipates as you hopefully catch up on an accrual here. Does freight also improve? And then as you think about the benefit of freight rise into the back half? And then as you think about the efficiency efforts, can you talk about how they're proceeding and where you expect those efficiency efforts to play out in the P&L?
Yes. You're hitting on some of the 3 key big factors as we get into the back part of the year. We're pleased to see headwind on a year-over-year basis. From freight, we're in a better place now than we were a year ago certainly on that front, and that will continue as we get into the back part of the year based on how we currently have things projected.
The next question is from Michael Lasser with UBS.
One of the key debates right now on Target is what's the sustainable gross margin rate moving forward? And the first quarter performance is going to help inform the various perspectives on that. So with that being said, can you help bridge the gap in your first quarter 2023 gross margin performance versus 2020 -- excuse me, 2019? I know you said that 100 basis points of the gross margin decline versus last year was shrink. I think you previously said that heading back to last year, there was a 150 basis point drag. So is it right to think that the -- more than 2/3 of the decline from this quarter to 2019 was just shrink related?
So I'll take a swing at that, Michael. The -- as I said in my remarks, the big drivers, speaking on a year-over-year basis of margin in the first quarter, we had a tailwind from freight. We already talked a little bit about the benefit we're seeing there on a year-over-year basis versus 2019, freight is still a headwind, to be clear. But on a year-over-year basis, we're seeing some benefit. We also saw some benefit on a year-over-year basis on the markdown and think salvage front as we recover from some of the inventory actions that we started to take last year. And then we saw the headwind from shrink, a full percentage point in the first quarter on a year-over-year basis. Like I said, if the current trends were to continue, we'd see that drag from shrink to be front half of the year loaded and kind of how it shows up throughout the year. But you're hitting on the key -- 3 key drivers on a year-over-year basis.
Okay. And my follow-up question is, the other area of discussion is going to be how do you get this flattish comp for the full year in light of what proceeds to be deteriorating macro situation. So perhaps you're going to make some purposeful choices trading off some margin in order to drive traffic? And if that's the case, how much are you willing to sacrifice the profitability in order to maintain the top line performance as we move into the second half of the year and beyond?
I'm happy to start. Christina, feel free to chime in. We think about it a little differently than that, Michael, in that as we think about the last back half of the year, I mean, we're going to drive traffic in a lot of ways, but it's not a simple trade margin for traffic play. It's about being relevant for our guests in the moments that matter. And is evidenced by the strength in traffic we saw in Q1. With the balance we have across categories, we can appeal to whatever is at the top of the guest shopping list. And first and foremost, that's how we think about staying relevant and driving traffic. So our guide for the year unchanged at the end of Q1 versus what we said 90 days ago, incorporates our best view of how we see all of those puts and takes playing out. And it's a wide range on the top line and the bottom line, but we believe is appropriate from the variables as we digest them sitting 1 quarter into the year. Christina, feel free to -- is there anything you'd add?
Yes. I agree with Michael, 100% that we aren't looking to make those 2 trade-offs. What we do instead is we look at where is there potential for us to take share because our unique proposition in the market might play really well under these circumstances. But in the discretionary categories, we're going in with a very conservative posture. And so it's the strength of our multi-category portfolio and the guests choosing Food, Beverage, Household Essentials and Beauty that's creating the majority of the traffic gains that we're seeing right now.
Michael, the only other thing I would add is as we think about leveraging our multi-category portfolio in this environment, we have the advantage of a nice balance between national brands and the continued strength we see in own brands, particularly at a time when our guests are looking for that affordable joy from Target. So we do think we're uniquely positioned to continue to maneuver through a challenging 2023 through the strength of our multi-category portfolio, the great national brand partnerships we have, complemented by our own brands and the flexibility we built into our system by reducing inventory and giving us the ability to flow fresh new items that are trend right for our guests.
Our next question is from Karen Short with Credit Suisse.
I just wanted to ask a little bit about your -- you had a lot of discussion in terms of price points that are going to be lower in discretionary. So I guess my question is, how much of there -- how much of your weakness in discretionary is just a misperception on your actual price point and your value proposition? That's my first question.
Karen, why don't I start and address the last point because as we sit here today, we think about what's happening from a theft and organized retail crime standpoint. It's an urgent issue, not just for Target, but across the entire retail industry. It is a problem that impacts availability of product, the shopping conditions are less convenient. And unfortunately, what I'm most concerned with is it puts our team and our guests in harm's way. So we are working right now with NRF, our partners at [indiscernible], other retailers across the country to make sure that we can talk to legislators that we can work with law enforcement to make some industry-wide changes and we're advocating for public policy changes to address the growing issues that surround all of us in retail today with theft and organized retail crime.
Yes, that's absolutely right. We have been talking about unit share for many, many, many quarters in a row because in many cases, we didn't actually raise our prices as much as the market. And we maintained that affordability. And so that has continued to help contribute the traffic gains that we've seen and the performance that we've seen in aggregate. Our value proposition is always a balance between expect more and pay less, and we're always going to play up that. And so the opportunity for us is to make sure that we are cutting through in our -- with the clarity of our promotions that we continue to put those great items in front of the guests and our merchandise displays and that our website reflects the incredible value that we do offer.
Our next question is from Rupesh Parikh with Oppenheimer.
I just want to get your perspective in terms of what you're seeing right now in the promotional backdrop. And then for Q2, just curious if you guys have assumed a more promotional backdrop in Q2?
Right now, there's no question that guests are seeking deals. The opportunity to balance their budget by finding deals is very visible. As I just talked about, the way that we're continuing to evolve our proposition is make sure that the deals that we do offer are certainly competitive with the market, but that they're increasingly more personalized. And as has been said a couple of times now, the inventory position that we're in right now gives us the ability to compete with the market but not chase the market down. And so that's what we're really excited about. We have an agile playbook that will allow us to continue to go after creating relevance for our guests and offering value but keep it rational.
Great. And then my follow-up question, just on the shrink, I think per estimates, I think shrink is now $1 billion-plus headwind over a 2-year basis. Does your team feel that you can fully recover that headwind over time? And then with some of the efforts that you already have in place, are you starting to see traction with any of those efforts, even if they're maybe in the early stages?
John, why don't you talk about some of the mitigation efforts we put in place?
Yes, I think -- as we think about mitigation efforts, I would go back to, first, what Brian said, it starts, first and foremost, with creating a safe environment for our team and for our guests. And there are multiple approaches to that, that also have a financial impact. So clearly, there is what we do with merchandise and how we display it and how we make that available to a guest. There is assortment changes that we can make to improve that performance as well.
Our next question is from Simeon Gutman with Morgan Stanley.
Brian, and it's been said a few times, the consumer is becoming more cautious. Can you talk about the competitive backdrop? I think it's natural that it's gotten more competitive. It sounded like that in Christina's remarks. Can you maybe give perspective on how it compares maybe to last year or even pre-COVID?
I think we've seen pretty consistent trends year-on-year. One of the things, as we think about discretionary categories, Simeon, and we talked about this in February at our financial community meeting. While we have seen some softness, last year, we generated almost $55 billion of revenue in those discretionary categories. And if we go back to pre-pandemic, we've seen sizable gains across all 3 of our major discretionary categories; apparel, home and hard lines. So there's still a consumer who's shopping those categories.
And then a quick follow-up maybe for Michael. The negative flow-through in Q2 looks like it's higher than that of Q1. And there is some movement in math given the comparisons here. Curious, why shouldn't there be more margin recovery in Q2 even on the negative comp or potentially negative comp?
Yes. I think I've hit most of the key themes there already. Just to repeat a couple, we're positioned in the top line conservatively and that means what leverage looks like in an inflationary cost environment throughout the P&L looks different planning for a slightly negative comp in our guide for Q2. So you see some deleverage there. And then we've talked a few times, the headwind of shrink will be present again in Q2, and that's more of a front half of the year thing than a back half of the year thing. But those would be some of the key things that we'll watch as the quarter plays out.
Operator, we have time for 1 final question today.
Our final question is from Dean Rosenblum with Bernstein.
I want to just follow up on the gross margin questions first. So you mentioned that relative to 2019, rate is a headwind, shrink is a headwind, et cetera. When we talked back in the fourth quarter event, we've asked about the notion of permanent sort of impairment to gross margins. We're looking at gross margin historically. In the second quarter with gross margin above 30%, can you give us some idea of where you might expect gross margins to come in for the second quarter? What might you consider middle slice and may be ambitious for gross margins for the second quarter?
Yes. Our expectations for both margin and SG&A and the rest of those are all baked into that EPS guide. And so as you guys know, we don't break out the specific components in our guidance. And the other thing I'd note, you probably heard me say this before, quarterly margins have more noise in them than I think sometimes the group here might appreciate. And so stepping back and seeing the margin trajectory over a longer period of time, I think, is going to be important. And we've got some work to do on that front. It's baked into our guide for the year to recover some of the margin pressure that we saw last year.
All right. So that concludes our first quarter call. And we appreciate all of you joining us and look forward to talking to you later this year. So thank you.