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Target's online sales surge in Q1, but can it last?

Target beat its first quarter earnings forecast amid the coronavirus pandemic. Moody's Vice President and Retail Analyst Charlie O'Shea joins Yahoo Finance’s On The Move to break down Target’s latest earnings report.

Video Transcript

JULIE HYMAN: And one of the other things that may be contributing to some of the gains in stocks are the continued re-openings around the country-- Ohio, for example, lifting its mandatory shelter in place order. So not quite a reopening, but a loosening of some of the restrictions. Here in New York state, Governor Andrew Cuomo, just in his daily presser, reporting the death count overnight at 112-- so a bit higher than the day before, 105, but continuing to trend lower as the various physical distancing measures seem to have been effective. So let's get into those retail earnings now. Specifically, I want to talk Target, which saw an enormous increase in its digital sales. Its comparable sales were up 10.8%, but it also saw an increase in expenses of $500 million. The shares are trading down by a little more than 1% today.

Let's bring in Charlie O'Shea. He is Moody's vice president and retail analyst. He's joining us from New York City. So, Charlie, as you weigh the sort of sales increase and the expenses increase and also look at the decline in the shares, is that what's going on there is that investors or traders are focusing more on that expense increase today?

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CHARLIE O'SHEA: That's an interesting question, Julie. Thanks for having me on. I don't really know. I don't know what people expected this quarter. This is the most volatile quarter-- and I think every retail CEO will say the same thing-- this is the most volatile quarter anybody could possibly imagine. You can't model for this, you can't plan for this, so you're doing a lot of things on the fly that maybe you never anticipated doing before.

So on the expense side, we've seen everybody's expenses climb. I also cover Amazon. Amazon's expenses were up. Costco has reported sales, but hasn't come out with a quarterly yet. Their expenses will be up. Everybody's expenses are going to be up dramatically if the stores are open. Margins are going to get hit, but that's just the way it's gotta be for a while.

And I think what you have to focus on is where the expenses are coming from. And you're seeing coronavirus-oriented expenses. A lot of those are onetime, but not all of them, because I don't think you're going to get away with not cleaning your stores going forward in this environment. And the rest of it's probably got to do with online-- with explosive online sales. We're seeing, you know, three or four-year pull-forwards of online sales volume for brick and mortar retailers, and that's not free. It costs them money, and it costs them margin. But I think that the punch line here is the consumers are gravitating towards these retailers and how many of them are going to stay once things return to normal.

ADAM SHAPIRO: Well, Charlie, I guess one of the things you're pointing out, though, is balancing behavioral changes from the consumers and these margins, for instance, Target-- it was $500 million in expenses because of coronavirus, but that's eventually going to go away, whereas what they've pulled forward in e-commerce, that you expect to be sustained. So long term, that looks pretty healthy, doesn't it?

CHARLIE O'SHEA: It is very healthy, Adam. And I think what we've seen in the past and what we've been kind of pointing toward is that point in time where those curves cross with online versus brick and mortar-- for brick and mortar retailer. And that's accelerating right now, because they're starting to see some of the efficiencies that we thought would come over time. And some of those are probably already being generated right now. It's just hard to say to sort through everything to really see how much is happening.

So I think it's not-- I don't think you can expect Target's online sales velocity to continue like this in perpetuity. The law of large numbers doesn't allow that-- or Walmart, for instance. Walmart's online sales were up 80-plus percent, and that's a $20-plus billion base. So I think what you're going to see going forward is some normalization of that. But you also are going to see a lot of consumers that never did anything online, never really took advantage of buy online, pick up in-store, have started to now, and are going to get much more comfortable with it. So you'll see the growth accelerate. The question is, how fast and how long does it last?

DAN HOWLEY: Charlie, I want to ask kind of on that-- where does that leave, then, the brick and mortar? Do we just start to see a real decline there for Target? They had done a lot of improvements in their stores. They made the experience much more approachable for consumers. You know, they had those checkout lines despite how horrible everyone looks in the cameras now. But where do we see that leading to? Do you just see these folks who you said may never have gone online before, continuing to go online, and then Target just kind of has to say, well, maybe we have to shutter stores now?

CHARLIE O'SHEA: No. Absolutely not. I think what we're seeing here is the power of the store when integrated with an online business. Walmart has 5,400 physical locations in the US that are all mini-distribution fulfillment centers. Target has 1,800-plus. Those are being leveraged right now, and we're really seeing the counter to the brick and mortar is dead argument. And we were never really in that camp.

We always felt that when the brick and mortar retailers really started to hit their stride online and focus on it, that they would find that those stores were tremendous assets. I think you're seeing that now. Brian Cornell called out this morning-- and this seems like a mantra for Brian every quarter-- which is 70, 80-- this quarter, around 80% of our online sales were fulfilled in the store. That means that they're really leveraging and doubling down on that store base. And buy online, pickup in store, I think the key word there is "store," not buy online.

And the stores-- you know, the retailers that have been closed would have been able to do online pickup, curbside pickup-- Best Buy comes to mind. I think you're going to find that they've done really well this-- during this pandemic. And what they've learned from that and the lessons they're learning during the pandemic will translate into the future. The question is, how much of the volume do they actually retain? And I think it's unrealistic to assume that they retain certainly the lion's share of what they're getting. I think they'll get incremental, but they're not going to-- you know, Walmart's not going to see 80% online sales growth forever, and Target's not going to see a doubling. It'll come back to a rational level. But I think what we're seeing is the consumer recognizing how important those stores are and how convenient it can be and how fast you can get product.

JULIE HYMAN: Charlie, just quickly, I also want to ask you about pay for employees. Because as far as I've seen, Target's one of the companies that is keeping its so-called hazard pay or pandemic pay in place for the longest-- that boost. I think it's keeping it through early July. And our reporter Brian Sozzi earlier told us that Brian Cornell is talking about maybe even just keeping that increase in place. What's the investor appetite for something like that? And is that the right move?

CHARLIE O'SHEA: Well, one of the issues that retailers have faced forever is turnover. And I can remember I've been doing this at Moody's for 17 and 1/2 years, and I can remember hearing retailers say our turnover is 100% a year. I'd sit there and say, what? You're turning over a new fleet every year. That's not cost effective. So I think if you pay a little bit more upfront and then you offer them benefits, they'll stick around longer.

Then you don't have to worry about retraining them, you don't have to worry about doing background checks and all that kind of stuff. You don't have to worry about the recruiting process. You don't have to tie up a huge human resources team in attracting new employees on a constant basis. So I think-- and then you get better employees, which take better care of the customers.

So I think you have to kind of weigh-- and again, this is another curves crossing analysis-- but at what point does that extra, say, $2 a share-- or I'm sorry, $2 an hour mean for employee retention and customer service scores?

JULIE HYMAN: Right. You could also argue it's just a sort of kinder, gentler way to do business. Charlie O'Shea, thanks for joining us. Charlie is with Moody's.