Target shares take a beating after investments take a toll on margins

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Target Corp. shares tumbled 10.4% in Tuesday trading as major investments in areas like technology and fulfillment took a toll on margins.

Target TGT, -10.53%   reported a margin decline to 28.7% during the third quarter, after margins of 29.6% last year. The company said supply chain costs owing to digital fulfillment and other expenses related to holiday inventory are the cause.

Target Chief Executive Brian Cornell, at one point during his earnings call commentary, highlighted his repeated use of the word “investment.”

“Now we’ve been clear that all of our efforts to grow and transform Target involve a commitment of resources which explains why I’ve already used the word investment five times in these remarks,” he said, according to a FactSet transcript.

Read: Red Tuesday for retailers, as Target’s stock suffers worst stretch since the financial crisis

Chief Financial Officer Cathy Smith also commented on the company’s margins during a call with the media.

“While we are seeing some pressure on our operating income and gross margin rates from the brisk pace of digital growth and the investments we’re making to transform our business, we’re on track with our long range plans,” she said. “By using our stores as hubs for delivery and pickup, we deliver faster to guests while reducing costs for fulfillment and last mile. We’re just now moving to scale and Q3 was a huge step in that direction.”

Heading into the all-important holiday season, Target announced new “skip-the-line” mobile checkout technology and free two-day shipping on virtually any purchase among its shopping perks for customers.

The retailer, which is locked in a battle for market share with retailers like Walmart Inc. WMT, -2.73%   and Amazon.com Inc. AMZN, -1.11%  , is also focused on private label brands, toys and other core merchandise categories, and its stores, including remodels and small-format layouts.

Target reported a 5.3% increase in comparable traffic, 5.1% growth in same-store sales, and 49% digital sales growth.

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“This is way above what most investors would have expected at the start of the year, and it implied continued share gains,” wrote Credit Suisse analysts led by Seth Sigman in a note. “That said, more concerning for us is the gross margin trend, the 18% inventory growth and weaker flow through. We expect this to be [a] focus initially, reminding the market of the significant costs to support that top-line growth.”

Still, other analysts are more upbeat.

“Target’s Q3 results reflect the continued favorable impact of its multiyear investment strategy, with impressive sales growth both in stores and online, with minimal negative impact on margins, indicating leveraging of these investments,” said Moody’s Lead Retail Analyst Charlie O’Shea.

“With market share gains across all five core merchandise categories, offerings are clearly resonating with consumers, and we believe the myriad private and exclusive brand rollouts are leading the charge.”

Target reported revenue of $17.8 billion, up from $16.9 billion last year and ahead of the $17.7 billion FactSet consensus.

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Neil Saunders, managing director at GlobalData Retail, is also “impressed with Target’s progress” and says the retailer is heading into the holiday shopping season “in extremely good shape.”

But Saunders also takes note of the 3.3% decline in operating income to $819 million.

“While this is unfortunate, we see this decline as necessary to support Target’s growth ambitions,” Saunders wrote in a note. “Some on Wall Street may lament the dip, but the truth is you cannot reinvent a retailer on the cheap. Target is not doing that and we applaud them for it.”

Target shares have gained 6% in 2018 while the S&P 500 index SPX, -1.82%   is down 0.5% for the period, the SPDR S&P Retail ETF XRT, -3.38%   is down 1.1%, and the Amplify Online Retail ETF IBUY, -1.85%   is up 2.4%.

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