Target Q3 Earnings: Tax Benefit Helps Meet Expectations As Both Sales And Margins Disappoint

Target (NYSE:TGT) just announced its earnings for the quarter ended October ^[1]. With an earnings per share of $0.86 that met the consensus forecast ^[2], at the outset, it seemed like the retailer did well during the August-October period. However, its stock price suggested otherwise, as it declined by as much as 5% on the earnings day.

Digging deeper, we see that in the previous earnings release, the company had guided for higher levels of sales growth and margin improvement than it was able to achieve in Q3. It also fell short of e-commerce growth targets, which is a key part of its turnaround strategy. The EPS figure was not indicative of these trends because they were offset by a tax benefit of $0.11 per share related to investment losses in Canada. While the company has marginally raised the lower end of its full-year earnings guidance range, the underlying business strength seems to have softened a bit.

Below, in this article, we will take a closer look at the trends observed during this quarter and also discuss ways in which Target is trying to regain lost momentum. We are in the process of updating our model per the Q3 earnings release.

See our complete analysis for Target

E-commerce And Key Category Sales Fall Short Of Expectations

Target’s CEO Brian Cornell had brought in a lot of optimism when he took over the role about an year ago. He gave the company the much-needed course correction after it had put its strengths (signature categories) in the back seat and instead focused on growing the groceries business. After taking up the role, he brought back the focus on signature categories and also prioritized e-commerce as a new source of sales growth. However, in the recent quarter, Target could not meet the expectations it had set for itself on these very metrics.

While the signature categories (baby and kids’ apparel, women’s wear and wellness items) continued to be the fastest growing segment at 4.8% comps growth in Q3, it was significantly lower than the previous quarter’s 7.2%. On the other hand, in e-commerce, the company had set itself a target of 40% growth this year, but could only manage 20% growth in Q3 (and 29% year-to-date). Given the expected 20% growth in Q4, the full-year number is likely to fall in the 25%-30% range. The fact that Target under-performed in its key focus areas raises some concerns around its growth prospects in the near term and more importantly, raises questions on whether the turnaround plan can actually turn things around.

Margins Stay Put, But Target Had Promised More

Gross margin in the third quarter was reported at 29.4%, 10 basis points lower than that in the year-ago period. While there was an increase in the share of higher margin products sold this quarter, the benefits were offset by reimbursement pressure in the pharmacy business and investments in product innovation. However, these costs are nothing out of the ordinary and were likely considered when Target guided for a 20-30 basis point margin increase at the end of Q2.

Fortunately, though, Target has already decided to sell its pharmacy business to CVS Health (NYSE:CVS) and will see some relief on the gross margin front after the transaction is closed. Moreover, it is on track to deliver cost savings of $600 million in 2015, $100 million more than what it had planned for. Therefore, we believe the company’s cost cutting initiative will act as a cushion to any margin pressures in the future and could also provide additional capital to be used for investments in technology and product innovation.

New Initiatives Could Help Regain Lost Momentum

In an attempt to regain lost momentum, Target has a few initiatives in place such as the free shipping policy for the upcoming holiday season and a renewed price match guarantee. Considering that 80% of Target’s shoppers start their shopping journey online ^[3], the higher traffic generated due to these initiatives will likely result in more store visits and eventually, higher sales. On the contrary, the price match guarantee comes at a time when price competition among retailers is already intense and could put the company’s margins under more pressure.

Therefore, we believe Target has a tough holiday season in front of it and a lot depends on how the company’s new initiatives pan out. Whether or not they work will only be known when the company announces its full-year results in February next year.

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More Trefis Research

1. Target News Release [↩]
2. Target Earnings Surprise, Nasdaq [↩]
3. Target Q3 Earnings Transcript, Seeking Alpha [↩]