Why Target Is Hitting, and Nordstrom Is Missing

In a retail landscape where Amazon.com (NASDAQ: AMZN) and Walmart (NYSE: WMT) loom large, and everyone else has to maneuver around them, Target (NYSE: TGT) is putting together a remarkably effective strategy. But if the discount chain has been making it look almost easy, with its eight straight quarters of comps growth, high-end department store chain Nordstrom (NYSE: JWN) is demonstrating just how hard it can be.

In this MarketFoolery podcast, host Mac Greer and Motley Fool senior analysts Emily Flippen and Jason Moser discuss the latest earnings reports from these retailers, and weigh the underlying factors that have led to their diverging fates.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

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This video was recorded on May 22, 2019.

Mac Greer: It's Wednesday, May 22nd. Welcome to MarketFoolery! I'm Mac Greer and joining me in studio, we have Motley Fool analysts Emily Flippen and Jason Moser. Welcome! How are we doing?

Jason Moser: Hey, hey!

Emily Flippen: Doing well!

Greer: Well, it is good to be here! We're going to talk some Nordstrom, we're going to talk some Lowe's (NYSE: LOW). Woof, woof! That is a double woof on those. We'll get to that.

But let's start with Target getting it done. Shares of Target up more than 9% on earnings at the time of our taping here. Same-store sales up more than 4%, 4.8%, Jason, for the quarter. Now, we've got strong growth in their digital sales, that includes orders that you make online and pick up at the store. Jason, what's not to like here with Target?

Moser: There is not a lot in there to not like. And that's a weird way of saying you have to like exactly what they reported here this quarter. I mean, in a world where Amazon and Walmart have really been at the forefront of the conversation here, and Walmart, obviously, investing a lot of money into growing their e-commerce business and competing more with Amazon, Target has kind of been able to sort of just keep under the radar and do their thing. But you look at what has gone on over the past few years, CEO Brian Cornell has going to be feeling really good about where things stand right now. And it's not to say that it's been a straight line up. But when he got there, I think back in 2014, I mean, there was the realization that they needed to make investments in digital and become a 21st century retailer. And lo and behold, I think they've gotten there. If you look at some of the numbers -- we talked about comps there, this was actually their eighth consecutive quarter of comp growth. When you look at digital sales, up 42% for the quarter, digital accounted for more than $5 billion in sales last year, supposed to account for more than $6 billion in sales this year. Now, when you put that in context of a top line that's around $76 billion, it's not obviously super important, but it's becoming more important as time goes on. And obviously, it's gaining some traction.

Flippen: It was a good quarter for Target, for sure. But you'll notice that with all of these great comp improvements, and while it is notable that Target is such a retailer that's succeeding in such a challenging industry, it's still a retailer. So you'll notice that despite the company continuing to raise revenue, their cash flow from operations were actually negative. They actually paid out more in cash than they brought in. That's largely thanks to the fact that they're really paying down in large portions their $10 billion of accounts payable. There's a little bit of, I guess you could say earnings management going on here as well, because they knew it was going to be a good quarter, so they take that hit during the quarters when people are going to be focused on the near 5% same-store sales growth.

Greer: OK, so you're saying maybe we need to slow our roll a bit with Target.

Flippen: I don't think you should slow your roll. I still like Target as a company. But I will say, it's still a retailer. I think people can kind of forget that when you have quarters like this. Target is differentiated, has a differentiated strategy. But it still takes a lot of financing and a lot of work to make these companies succeed over the long term. And you'll notice that management expected growth to slow slightly throughout the rest of the year. So, while it's a good quarter, I like Target in general, personally, I think there are better places to put your money.

Greer: OK, let's talk about that. Jason, you mentioned some of the competition. Who's the bigger threat to Target: Walmart or Amazon?

Moser: I would look at Walmart as probably being the bigger threat because it's the more comparable of the two. Walmart and Target are kind of those traditional retailers that are having to pivot and change their business model a little bit, at least, in order to compete more with Amazon. One of the signs that they're doing a good job of it, they wanted to put their physical stores at the center of their fulfillment. That's that ship-from-store mentality that a lot of these retailers are approaching these days. They handled over 80% of their digital volume from the actual stores. So they've done a good job of turning those stores into stores/fulfillment centers.

But I think Emily makes a really good point here -- it costs a lot of money to keep that operation going. It's not like they've reached the finish line and now everything's hunky dory. I mean, this is stuff that they had to just keep on doing essentially on into forever in order to stay competitive. And it really is one of the most competitive markets out there today, when you look at what Amazon and Walmart are doing as they jockey for position. So, I mean, yeah, good quarter, for sure ... I don't personally own shares of Target. I don't know that this report makes me want to own shares of Target. But I mean, you have to commend them for a job well done.

Flippen: Definitely. Target's always been forward-thinking in that regard. I'd also have to agree, though, that Walmart seems to be the bigger threat. I use "threat" loosely, because I think there's a world in which Target and Walmart both succeed. But in terms of direct competitors, while Amazon does have some overlap, I think the core customer Walmart is trying to win over from Target by introducing things like their own independent retail lines for clothing, changing their pricing structure, changing the experience of shopping in their stores, improving the online pickup sales. All these areas that made shopping at Target a more pleasant experience than shopping at Walmart, management of Walmart is slowly trying to change.

Greer: I was surprised when I was looking at the stock, and looking at the stock chart over the last five years. Shares of target are up, but Target has lost to the market over the last five years. When you look out over the next five years, do you think Target's a market-beater?

Moser: We had that same question in regard to Walmart, when we were talking about Walmart vs. Amazon. I could see a world where Walmart could very well be a market-beater. I think Target's got a little bit of a tougher road ahead. I think that the biggest problem for them is going to be the spending that they're going to have to do on an ongoing basis. I think that could prevent the stock from offering any real attractive gains for investors. I mean, I don't know that I'd be looking at Target today as an investment where I'd call it a market-beater.

Greer: They made a big kerfuffle this week with their partnership with Vineyard Vines. You know, the pink whale? It's kind of stylish. I think of them as Polo-esque. And this stuff just immediately sold out online on Saturday, and in the stores on Saturday, so much so that by Sunday, there were 9,000 of these Target-Vineyard Vine clothing items on eBay already.

Moser: Which is insane! I guess we never really thought of Walmart and/ or Target as fashion-forward companies. I think we posed the question more than once that, with Walmart, certainly, making some of those acquisitions and trying to become a little bit more of an e-commerce business and bring some brands under their umbrella, does a brand lose some cachet when it becomes a part of the Walmart family? The same question should be asked of Target? Does a brand lose some of that cachet if it becomes part of a discount retailer's world? I don't know. I mean, I would think probably.

Flippen: Maybe not as much as it used to. If you're not competing on price, you're competing on service. Historically, Walmart's always been the price leader and Target's been that service leader. And having Vineyard Vines is probably part of that service experience. You're getting that distribution, that demand, but you're not really taking the brand to as low of a level, I guess you could say, as Walmart.

That being said, like I said, I feel like Walmart is slowly moving to be both a low-cost provider and a service provider. If they're able to succeed in doing that, then one trick ponies like Vineyard Vines aren't going to be enough to save Target.

Greer: OK, well, I think a brand loses cachet when I start to wear it. [laughs] So, that's probably a good sign for Vineyard Vines. I don't wear Vineyard Vines.

Moser: Unless it's Kirkland. Kirkland, that's when it's on the way up.

Greer: It's timeless. You mentioned it, and I was so excited, Washington Post's Food section today, they review all the local hot dogs. What is the best hot dog? And they have them ranked. There's 20 or 25 of them. No. 1: Costco!

Moser: I just don't understand that!

Greer: How great is that?

Moser: How is that even possible? What makes it so great? Is it just because of the price?

Flippen: It's the price!

Greer: I've never had one, but I cannot disagree with it.

Moser: Wait a minute, you've never had one?!

Greer: No.

Moser: I mean, you come in here on a daily basis, touting the merits of your Costco membership!

Greer: I know.

Moser: You've never had -- I don't know what I can ask anymore!

Greer: I'm just so excited to get all this stuff home, I can't take time to have a hot dog there. OK, let's move on to Nordstrom. Wow, really struggling here! Shares falling more than 8%. Weaker than expected earnings, and Nordstrom cutting its full-year forecast. Now, Emily, among the culprits here, problems with Nordstrom's loyalty program. That seems bad. And, slowing sales of full-priced women's clothing, which, I understand from my limited experience at Nordstrom, that is an important part of the product mix.

Flippen: It is an important part. This 57% decline in earnings year over year is definitely representing that. What I think is interesting is that management chalked it up to executional misses, essentially acknowledging the fact that they made a lot of mistakes, one being the changes to the loyalty program. They didn't send out flyers. It turns out, a decent number of people relied on these flyers to remind them to go into the Nordstrom stores.

Greer: I love that! So, a victory for snail mail. Turns out, people still want something mailed to them.

Flippen: Or, a loss to Nordstrom, which might tell you something about their core customer, right, if they're still relying on these snail mail catalogs, I guess you could say, to remind them to shop at Nordstrom. But, they also said there's a poor merchandise mix. That goes into women's clothing. This is what we've been citing as a main concern -- at least, I've been citing as a main concern -- with a lot of traditional retailers, especially clothing retailers. They have to order, purchase, and stock inventory, which is essentially trying to predict what people are going to want to buy. And they keep losing out to the TJ Maxx and Burlington companies of the world, because they don't care what inventory they have. They stock a little bit of everything. It might be off-season, it might not be the newest thing, but that doesn't matter to them. Nordstrom needs to predict trends and fashion and demands. It's in part what killed JCPenney, poor merchandising management. So, Nordstrom, this quarter to me says, the main thing they're struggling with is expertise and merchandising.

Moser: It's a very difficult space. We talk about it all the time, sustainable improvement in the specialty retail fashion style investments, it's just really difficult. Emily really hit the nail on the head there. They have to just be really good about predicting fashion. And then, not only predicting the fashion, but predicting how much of it they're going to sell. You look at a lot of these retailers' balance sheets, and when you see those inventory numbers start getting little bit inflated, that's a double whammy. Not only is the inventory becoming inflated, but as time goes on, it becomes even more obsolete. So they essentially just end up writing all of that stuff off, or selling it to these other stores in the value chain for next to nothing. When they're succeeding, yeah, the market recognizes that. But very difficult to succeed on a sustainable basis.

Greer: And it seems like one of the trends -- I'm going to posit this as my fancy pants theory here -- as a society, especially in the U.S., we've become much more casual over the last 20 years.

Moser: Oh, for sure!

Greer: Men, women. You don't see near as many business suits. There's not near as much of the need for that nicer formal or semi-formal clothing. Doesn't that hurt Nordstrom, when people are gravitating to athleisure wear and they're wearing jeans to the office?

Flippen: Yeah, I definitely think so. I was having this conversation with a couple of friends this weekend, about the different clothes we wear to work. And at no point have I felt compelled to spend a few hundred dollars on a work suit or something. And that's not just because I work at The Motley Fool, where we're very casual. My friends as well, who have more professional jobs -- not to say The Motley Fool's not professional! But, a more professional setting job. And they do the same thing. It's much more casual. It's hard to compel people to spend that much money. And if somebody is spending that much money on clothes, there are so many different ways to buy and consume those clothes that don't involve shopping at a place like Nordstrom.

Moser: Yeah, just watch Joseph A. Bank and Men's Wearhouse. That's a good example, those two essentially combined. I think they've got a long road ahead as well, because that's all they really sell, is that formal attire and banker suits and whatnot. You just don't see people dressing the same way these days.

Greer: So, when you look at Nordstrom, the stock, shares down more than 40% over the past five years. What does it take to right the ship?

Flippen: That's a good question. I think they put a lot of money into things like Trunk Club, trying to reach a different demographic, make it more accessible. But they've been sucking wind on Trunk Club, that being their style delivery service, very similar to Stitch Fix. They haven't really found a way to monetize that. I think the main issue is that ultimately, they're still a department store. Department stores are very expensive to run. And they haven't really made changes to the way that they procure clothes. So I think it's going to take an entire business overhaul or potentially a cultural overhaul for the United States to really save this company.

Greer: Any chance they get acquired?

Moser: I mean, certainly possible. But, you look at businesses when they're having problems, it's either a fundamental problem with the business or it's a problem in the market that they actually serve. I think that's where Nordstrom really has a problem. The market that they serve has fundamentally changed over the past 20 years. It's going to be very difficult for them to pivot because they essentially have to lose their identity in the process.

Greer: But you're saying, if they become something completely different, [laughs] they have a chance?

Moser: [laughs] That could be a solution!

Greer: It's never a good sign!

Moser: Throw up a few Nordstrom frozen yogurt stands across the country, everybody loves froyo.

Flippen: Planet Fitness is looking for real estate, I hear. Maybe Nordstrom development should just be selling everything to Planet Fitness.

Greer: I like it! Speaking of the storm that's coming, this has nothing to do with a storm that's coming, but it's my desert island question! Let's say there's a storm coming, or there's not --

Moser: A storm put us on that desert island.

Greer: Exactly! It's like Gilligan's Island. You're on the desert island, and you have nothing to do, but you want to invest. And magically, somehow, you're able to invest in one of these five companies. I'm going to throw a few others that we've talked about in play here. And you've got to hold it for the next five years. Are you going Target, Walmart, Nordstrom, Lowe's, or Home Depot?

Flippen: Walmart for me, hands down. I like all the work that they're doing. I think their management is extremely thoughtful, both with their quick reactions with things like one-day shipping, online ordering, trying to bring brands in-house. I think there's still a lot of runway for Walmart.

Moser: I'm going to remain consistent. I ask myself every quarter why in the world I don't own shares of Home Depot, because I should. I would definitely go Home Depot!

Greer: I'm curious about renting a tile cutter.

Moser: Let's get together one weekend. I'll show you some stuff.

Greer: I need a lot of work. I just caulked our shower.

Moser: Hey, see!

Greer: No, I'm terrible at caulking. It looks bad. It's not good.

Moser: He doesn't give himself enough credit, Emily.

Greer: No, it's not good! I can't draw a very tight bead. I went on YouTube and I watched this guy caulking and, of course, he was great. But it just doesn't look at all like that.

Moser: It takes some work. Takes some practice.

Greer: Yeah, yeah, I need a lot of work. OK, Jason, Emily, thanks for joining me!

Moser: Thank you!

Flippen: Thank you!

Greer: If you have any thoughts on, well, cutting tile, or any of these stocks, or caulking tips, marketfoolery@fool.com is our email. As always, people on the show may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's it for this edition of MarketFoolery! The show is mixed by Dan Boyd. I'm Mac Greer. Thanks for listening! And we will see you tomorrow!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Emily Flippen has no position in any of the stocks mentioned. Jason Moser owns shares of Amazon. Mac Greer owns shares of Amazon and Costco Wholesale. The Motley Fool owns shares of and recommends Amazon and Stitch Fix. The Motley Fool recommends Costco Wholesale, eBay, Home Depot, Lowe's, Nordstrom, Planet Fitness, and The TJX Companies. The Motley Fool has a disclosure policy.