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Target Talks Rising Traffic and Falling Profit Margins

By Demitri Kalogeropoulos - Nov 21, 2018 at 6:30PM

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Highlights from the retailer's latest conference call with investors.

What a difference a year makes. At this point in 2017, Target (TGT 0.81%) was entering a difficult holiday season period that management predicted would result in flat sales growth. But this time around, the retailer has demonstrated healthy momentum heading into the industry's biggest weeks.

CEO Brian Cornell and his executive team recently held a conference call with analysts to put those trends into perspective and to add detail to their outlook for the fourth quarter and beyond. Below are a few highlights from that presentation.

A full grocery cart.

Image source: Getty Images.

Follow the traffic

There are many data points that show we are making great progress. But there's no better metric than traffic, which has been growing in the last couple of quarters faster than I've seen in my time at Target.
-- COO John Mulligan

Target has made several changes to its business over the past year, including investing heavily in its supply chain, improving its store shopping experience, and bulking up its digital selling infrastructure. Customer traffic growth is the clearest indicator that these initiatives are working, executives say. That metric came in at a robust 5.3% this quarter, which wasn't far from last quarter's record high of 6.4%.

Target also managed a market-thumping 49% boost in its digital sales, which management credited to the improved shopping experience and generous delivery options. Between the two channels, the retailer believes it won market share in each of its core selling categories.

Profitability pressures

Our third-quarter gross margin rate of 28.7% was lower than our expectations. This was the result of higher-than-expected supply chain costs driven by digital fulfillment, and the cost of receiving and processing a larger holiday inventory position compared with a year ago.
-- CFO Cathy Smith

Target saw its gross profit margin fall by nearly a full percentage point as costs rose while pricing remained low. The retailer's bottom-line profitability continued falling, too, with operating income margin dipping to 4.6% from 5% due to the combination of competitive pricing and spending on growth initiatives and the digital sales channel.

Cornell reminded investors that its rebound projects come with a price. "We've been clear that all of our efforts to grow and transform Target involve a commitment of resources," he explained. Executives are hoping these investments will start showing their full financial value soon as profitability stabilizes over the coming quarters. "We believe that this year will establish a sustainable benchmark for our operating margin rate over the longer term," Cornell said, "as we achieve a balancing point between the rate pressures and opportunities of operating an omnichannel retail business."

The holiday outlook

Our teams are focused and ready to deliver an outstanding holiday season in terms of both sales and profitability.
-- Cornell

Target's updated 2018 outlook amounted to a confirmation of its previous forecast, with sales expected to rise by about the same 5% pace that the retailer managed so far this year. All of its rivals will be fighting for a piece of its market share, and in that way this period should be as competitive as it has been in recent years. But management's confidence has been bolstered by its healthy traffic trends, both in stores and online, and they see significant opportunities in attractive niches like toys, apparel, and alcoholic beverages.

On the downside, it's not clear when Target's profitability will end its slide. However, investors only have to look at rebounds in areas like customer satisfaction, shopping frequency, and online spending to see evidence of management's growth initiatives improving its relevance with today's consumers.

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