We question whether recent performance will prove sustainable over several quarters.
John Brick, CFA
11:13 AM | Email Article
reported fiscal 2017 first-quarter results that came in above expectations, but given the competitive headwinds facing the business, we don’t anticipate any change to our near-term outlook, as we question whether recent performance will prove sustainable over several quarters.
John Brick, CFA, is an equity analyst covering retail defensive stocks.
Our long-term forecasts--for 0.7% top-line growth, operating margins of 6.4%, and comparable same-store sales of 0.6% on average over the next 10 years--also remain in place. However, we intend to raise our fair value estimate by 5%-10% to account for our expectations for U.S. corporate tax reform beginning in 2018. Even after accounting for our revised valuation, we still view the shares as fairly valued.
In the quarter, revenue decreased 1.1%, driven by a comparable sales loss of 1.3%. Digital channel sales increased 22% to 4.3% of sales, slightly below our 30% estimate for the full year, and contributed 0.8% to consolidated same-store sales, which implies that physical stores comped negative 2.2%. We are encouraged by the direction of the digital business but note that these sales come at the expense of Target's margin profile. Because Target significantly lags its peers (generating just $3 billion of digital sales annually versus $16 billion for Wal-Mart and $55 billion for Amazon in North America), we maintain that it will need to invest heavily in its omnichannel presence to effectively compete. We expect these investments will constrain margins by 100-200 basis points relative to historical 7% levels.
Our concerns remain that Target is underindexed to grocery (a meaningful traffic driver) and overindexed to high-margin, price-transparent items online that may erode its above-average margins over time. We continue to view Target as having no moat, as competitive pressures mount, customer spending habits shift, and the company undergoes its multiyear transition.
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