There's at least one reason to believe that shares of retailer Target (NYSE: TGT) could have a great 2019: online sales growth. Thanks to various initiatives like free two-day shipping, Target managed to greatly accelerate its online sales growth in the second half of 2018. If that momentum continues into 2019, the market could change its tune on the stock.
But quick online sales growth may not be enough to push Target stock higher. Target's online growth, along with aggressive pricing to win customers, has been hurting margins. And with the company now lapping the corporate tax cut that became effective last year, Target's earnings growth in 2019 may slow way down.
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Even if the market loves Target's e-commerce progress, it may hate weak earnings growth even more.
Growth comes at a cost
Target's third quarter was fantastic in terms of sales growth. Comparable sales surged 5.1% on store traffic growth of 5.3%, and online sales rocketed 49% higher. Free shipping initiatives, a bevy of new exclusive brands, and lower prices all helped Target put up exceptional sales numbers in 2018.
But the bottom line didn't look nearly as good. While Target's earnings per share surged by 34% year over year in the third quarter, that growth was due solely to lower taxes and reduced interest expense. Gross margin slumped 0.9 percentage points year over year to 29.7%, while operating margin tumbled 0.4 percentage points to 4.6%. Operating income dropped by 3.3%.
Target's stores are the backbone of the company's e-commerce operation. Next-day and same-day deliveries via Restock and Shipt all come from Target stores, and many standard online orders come from the stores as well. This has saved Target the expense of needing to build out a huge network of online fulfillment centers, and it cuts down on shipping costs, since the orders start close to the customer. But online sales growth is still having a negative effect on the company's profitability.
Aggressive pricing is also playing a role. Backing out the online sales growth, third-quarter comparable store sales rose 3.2%, much slower than store traffic growth. Target is using low prices to drive traffic, which is great for sales but not so great for profits.
Target will still enjoy a lower corporate tax rate in 2019, but it will no longer provide a year-over-year boost to earnings. Target was able to chop its income tax expense by one-third in the first nine months of 2018. That won't be repeatable in 2019.
Much slower earnings growth
Analysts are expecting Target to produce earnings-per-share growth of just 4.1% in fiscal 2020, which begins in February. That number could be lower if last year's strong consumer spending gives way to weaker spending this year. Target CEO Brian Cornell called the consumer environment "perhaps the strongest I've seen in my career" last year. That will be tough to top in 2019.
Slower earnings growth is less of a big deal because the stock trades for a low multiple of earnings. Based on the average analyst earnings estimate for fiscal 2019, Target stock goes for just over 12 times earnings. That valuation already bakes in a slowdown in earnings growth. The stock could tumble if something close to the worst-case scenario plays out, but the market is already pricing in some pessimism.
Will investors care more about fast online sales growth than sluggish earnings growth in 2019? It's hard to say. Target is doing everything right online, and it's become dramatically more competitive over the past year. But profits are ultimately what determines a stock's value, and Target may have a rough 2019 on that front.
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