The narrow-moat retailer continues to benefit from its decision to part ways with its lossmaking pharmacy business and efforts to drive organization-wide efficiencies.
By Erin Lash, CFA | 11-16-16 | 02:55 PM | Email Article

While sales continued to languish in the third quarter, no-moat  Target  posted notable profit gains (gross margins expanded 80 basis points to 30.2% and operating margins jumped 90 basis points over last year to 6.4%) despite facing an intensely competitive environment and tepid traffic trends. Target continues to benefit from its decision to part ways with its lossmaking pharmacy business (which was sold to CVS for $1.9 billion), and efforts to drive organizationwide efficiencies. In light of its recent performance (and to account for the benefit from the early retirement of debt) as well as increased optimism for the holiday season, management raised its fiscal 2016 adjusted earnings per share guidance to $5.10-$5.30 from $4.80-$5.20 (above our $4.87 estimate). We plan to adjust our near-term outlook to reflect year-to-date results but don’t anticipate a material change to our $72 fair value estimate or long-term forecast, which calls for 3% annual sales growth and average operating margins north of 7% over the next decade. With the mid-single-digit jump in the stock, we’d suggest investors await a more attractive risk/reward opportunity, given the number of challenges that could stall Target’s trajectory.

Erin Lash, CFA, is a director of consumer sector equity research for Morningstar.

Comps ticked down just 0.2%, and while still negative, this was a moderation from the 1.1% decline in the second quarter. Traffic slipped 1.2%, as weakness in electronics and grocery persisted, although prices increased 3.5% and units per transaction ticked down 2.5%. Similar to the recent past, management attributed this improvement to signature categories that are growing at more than 3 times the rate of other categories. This suggests to us that an increased focus on its core competencies (style, baby, kids, and wellness) is bearing fruit. We're not convinced the solid back-to-school season performance will persist, with heightened competition making it difficult to exceed its updated comp range (down 1% to up 1%) during the upcoming holiday quarter. 

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Erin Lash, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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