Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Grocery Wars

How Does Target Survive in the Age of Amazon?

Few retailers are in a worse position in the age of Amazon (NASDAQ: AMZN) than Target (NYSE: TGT). The iconic discounter faces a direct competitor with incredible marketing savvy, an unmatched mastery of technology, and vast amounts of money.

For example, Target reported quarterly revenues of $18.422 billion and a quarterly gross profit of $5.236 billion on 3 August 2019. Those numbers sound impressive until you compare them to the $63.404 billion in revenues and $27.067 billion in gross profit Amazon recorded for the quarter ending on 30 June 2019.

Moreover, Amazon’s revenue grew at a rate of 19.89% last quarter. In comparison, Target’s revenues grew at a rate of 3.63% in its last quarter. Essentially, Amazon’s revenues are over three times as large as Target’s, and they are growing nearly five times as fast.

Can Target Compete with Amazon?

In particular, Amazon’s business model gives Jeff Bezos vast amounts of cash he can throw into new retail ventures and product lines.

Amazon reported an operating cash flow of $10.963 billion and a free cash flow of $6.475 billion for the quarter ending on June 30, 2019. On the other hand, Target noted an operating cash flow of $2.812 billion and no reported free cash flow for the quarter ending on August 3, 2019.

Meanwhile, Target reported $1.656 billion in cash and equivalents on 3 August 2019. Comparatively, Amazon had $22.616 billion in cash and equivalents and $18.847 billion in short-term investments on 30 June 2019.

Consequently, Amazon had $41.463 billion in cash assets it could deploy against Target. This leaves Target in a difficult position, because it will need to borrow money to finance expansion, new technology, and new products.

Can Disney Save Target from Amazon?

“To remain relevant, every business must also become a media business,” Medium contributor Erik P.M. Vermeulen. See Vermeulen’s essay The End of the Corporation for an elaboration of this thesis.

One of the few ways, Target can fight Amazon is to recruit allies. Predictably, Target is partnering with Disney (NYSE: DIS) for an anti-Amazon offensive.

In October 2019, Target will open Disney stores in 25 locations, Inc. reports. Each Disney store will feature Marvel, Star Wars, The Simpsons, and other popular Disney entertainment brands. In addition, Target will show Disney movie clips to customers in the stores.

Not coincidentally, the Target Disney stores will open a month before Disney’s streaming video service Disney Plus plans to launch; on 12 November 2019, CNET reports. Disney is launching Disney Plus to overcome Amazon and Netflix’s (NASDAQ: NFLX) growing stranglehold on streaming video.  

Can Disney Plus Save Target?

Disney Plus will feature Disney, Marvel, Star Wars, Pixar and National Geographic programming. In addition, Disney Plus will stream every episode of The Simpsons.

Not coincidentally, CNET claims you cannot watch Disney Plus through Amazon’s Fire TV platform. However, Disney Plus will be available through Xbox, Roku, PlayStation 4, Android, Chromecast, Android TV, Google Chromecast, iPod touch, iPad, iPhone, and Apple TV.  

Target’s hope is to add some Disney magic to its increasingly dated stores. Accordingly, Target plans to open a store near Walt Disney World in 2021. Furthermore, Target’s website now contains a Disney-themed section that could easily integrate with Disney Plus.

Can the Disney Magic Save Target from Amazon?

Partnering with the Mouse is a smart move for Target because The Walt Disney Co. (NYSE: DIS) generates a lot of cash.

Specifically, Disney reported $6.728 billion in cash and equivalents on 29 June 2019. Disney recorded an operating cash flow of $4.586 billion and a financing cash flow of $12.354 billion on that date. However, Disney reported a negative free cash flow of -$2.570 billion for the quarter ending on June 29, 2019.

Impressively, Disney reported revenues of $20.245 billion and a gross profit of $2.76 billion for the quarter ending on 29 June 2019. Therefore, Disney’s resources are a little bigger than Target’s. Yet Amazon’s resources still dwarf Disney’s.

Why Target Needs Disney

Disney and Target are partnering because they are facing the same aggressive, tech-savvy, and cash-rich competitor: Amazon. The hope is that Target and Disney can drive each other’s sales with synergy.

A mother could order Marvel TV shows for her kids to watch on Disney Plus, and Captain America pajamas for her son from, for example. In addition, the mother could pick the pajamas up at Target or have Target subsidiary Shipt deliver them.

In addition, Disney could finance new Target stores or upgrades to Target locations. Meanwhile, Disney can open dozens of new retail stores at little cost inside Target stores.

Will Target Survive the Trade War?

Strangely, one of the biggest existential threats to Target is the supposed trade between the United States and the People’s Republic of China. Target management admits President Donald J. Trump’s (R-New York) proposed 10% tariffs on some Chinese goods threaten its bottom line in a letter to suppliers, OPB reports.

“Target will not accept any new cost increases related to tariffs on goods imported from China,” writes Mark Tritton, executive vice president and chief merchandising officer for Target. “Our expectation is that you will develop the appropriate contingency plans so that we don’t have to pass price increases along to our guests.”

Therefore, Target will not pass price increases onto customers. Instead, Target expects suppliers to absorb the growing costs.

Only time will tell if this arrangement is workable. However, I imagine many suppliers cannot afford to go along with Target’s plans. Thus, tariffs could force Target to raise prices or eat the cost of price increases. Hence, the Trade War could hurt Target’s profits.

Is the Trade War for Real?

Conversely, it is hard to tell how serious Trump is about tariffs. In fact, Trump moved the start date of the 10% tariffs from 1 September 2019 to December 2019, on 13 August, The Los Angeles Times reports.

Trump’s tariffs could hurt Target because they include TV sets, shoes, keyboards, clothes, bedding, and many other products Target sales, The LA Times reports. Unfortunately, I cannot tell how serious Trump is about the tariffs. There is a strong possibility the tariffs are a campaign stunt to boost Trump’s appeal to Republican primary voters.

Notably, Trump announced the tariffs a few weeks before populist Republican Joe Walsh launched a primary challenge to Trump. News reports show Walsh plans to run as an economic nationalist to steal Trump voters.

Even if Trump is serious, the trade war could be a short one because America could have a new president and a new trade policy in January 2021. Thus, Target’s strategy of wait out the trade war makes sense from a political standpoint.

Can Target Wait out the Trade War?

Economic analysts think “wait it out” is China’s best strategy, CNBC observes.

“We describe China’s current strategy as endurance; the main goal is to preserve China’s economic resilience, while taking the higher US tariffs as a given fact,” Deutsche Bank economist Yi Xiong comments in a recent report.

Therefore, Target’s main source of supply; China’s factories, will be there and possibly more productive than ever when the trade war ends. Hence, Target could be able to offer a greater selection and lower prices when the trade war ends.

Target, however, will have to survive the trade war. Hence, the trade hysteria explains Target’s willingness to partner with Disney.

To elaborate, Disney is a cash-rich company that makes most of its money outside retail. For example, Disney’s main business is digital entertainment products; movies and TV shows, that it makes mostly in the United States and the United Kingdom.

In addition, Disney makes money from theme parks and resorts all over world. Thus, Disney has access to products and cash that are not dependent on China. Unlike, Target, Disney has little threat to its bottom line from the trade war. Thus, even a temporary alliance with Disney could help Target survive the trade war.

Is Target a Value Investment?

Target’s deep exposure to Amazon and the trade war make it a contrarian play, but is Target (NYSE: TGT) a value investment?

Presently, I say Target is not a value investment because Mr. Market overpriced its stock at $106.65 a share on 3 September 2019. However, I think Target is still a contrarian investment because of its dividend.

Target will pay a 66₵ a share quarterly dividend on 20 August 2019. Impressively that dividend grew from 64₵ last paid on 14 May 2019. Thus Target’s dividend will grow by 2₵ during summer 2019.

Moreover, Target offers investors an impressive 54 years of dividend growth, reports. In detail, Target investors received a dividend yield of 2.48%, an annualized payout of $2.64, and a payout ratio of 49.1% on 3 September 2019.

If you are looking a contrarian stock in retail Target could be it. This discounter has a long history of juicy dividends, and a clever management capable of leveraging strengths and partnerships. Exposure to Amazon and trade puts Target in a risky place, but I think the dividend justifies the risks.