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The Ratings Game: Target says measures to manage the supply-chain bottleneck has pressured margins, but analysts say it’s worth it

Target Corp. says a lot of effort and some extra expenditures have gone into managing this year’s holiday supply-chain network given global bottlenecks, but executives and analysts say it’s been worth the cost.

Target on Wednesday reported third-quarter earnings and sales that beat expectations, and says inventory is up more than $2 billion, or 18%, from last year.

See: Target blows past quarterly earnings expectations and says shelves are full for holiday season

But the company admitted that getting merchandise where it needs to be in the face of COVID-related challenges comes at a price.

“[O]ur teams are working diligently to get the right inventory to the right place at the right time,” said Christina Hennington, chief growth officer at Target, on the analysts earnings call, according to a FactSet transcript. “Doing so has driven some near-term gross margin pressure and appropriate long-term investment in the relationship with our guests. Bottom line, based on the incredible efforts of our team, we feel good about our inventory levels heading into the holiday season.”

Target is one of the large retailers that chartered its own ships to get around port backups and other problems.

Special report: This is how America’s booming demand for goods shattered the supply chain

Chief Operating Officer John Mulligan went on to say that Target is collaborating with government and port officials to get merchandise moving.

“A sizable amount of this inventory will continue to flow to our stores over the next few weeks, and our team has clear visibility to where the inventory is located and when it will arrive in our stores.”

JPMorgan analysts say the extra spend is good for gains down the line.

Also: ‘Fighting inflation is in our DNA’: Walmart says its pricing and inventory can deliver for the holidays

“We believe this is the right long-term strategy and will lead to further share gains (whereas other retailers seem to be pricing to maintain gross margin rate),” analysts said.

“We expect the gross margin decline to be a bit bigger” in the fourth quarter, the analysts wrote, forecasting a decline of 275 basis points vs. 255-point decline in the prior quarter, “but then recede as inventory turns and the mix shifts away from general merchandise. … Given Target’s share capture and it being the first to go through the gross margin expectations reset, this positions the stock well.”

JPMorgan rates Target stock overweight with a $292 price target, down from $310.

Quo Vadis is looking at the big picture for the company rather than focusing on individual pieces of the balance sheet.

“[A] focus on this line item seems incredibly short-term-oriented for a company that has proven its attractiveness of its model in an incredibly volatile environment and is taking meaningful share,” wrote John Zolidis, Quo Vadis’s president, in a statement.

“Longer term, bringing in double-digit increases in traffic on a mature store base accrues much greater to the long-term earnings power and cash flow of the business than does timing related pressures on COGS.  Note that Target did not drive traffic with discounts, traffic growth is organic and therefore should be sticky.”

Target reported comparative sales growth across its five core categories, which include food and beverage, apparel and home.

“We view maintaining and even expanding share off the outsized gains from last year as notable, and should help to dispel market concerns that the company would cede some of the pandemic-led growth as the U.S. economy moves to a more normal environment beyond COVID-19,” wrote Stifel analysts in a note.

Target gained $9 billion in market share in 2020.

“Further pointing to robust performance, Target outperformed Walmart’s comp by
350 basis points in the quarter, with outperformance most notable compared to mid-single-digit comp growth in general merchandise for Walmart.”

Also: Walmart faces labor, supply-chain pressures on margins despite earnings beat and holiday optimism, analysts say

Stifel rates Target stock buy with a $280 price target.

“We think a higher private brand mix and lower food penetration will make gross margin pressures more transient in nature,” wrote KeyBanc Capital Markets.

“Highly differentiated private brands should give Target more pricing flexibility should inflationary pressures persist and give it leverage against large national brands.”

KeyBanc rates Target stock overweight with a $280 price target as well.

GlobalData calls Target “one of the most successful retailers in the country” based on a “remarkable level of growth.” Neil Saunders, managing director at GlobalData, also said the company has benefited from the consumer’s willingness to splurge on a treat during the pandemic.

“Inflation is also modestly helpful to Target as, despite its more upscale offering, it retains a strong value for money position which is appealing to many households,” Sanders wrote.

“From our data, there some evidence of consumers trading down to Target in areas like fashion and homewares. At present this is a modest, but helpful, trend. However, should inflation bite further and faster, Target could benefit even more as more consumers look to make their dollars stretch further without sacrificing quality and style.”

Target’s stock has gained 42.6% for the year to date while the S&P 500 index
SPX,
+0.26%

has run up 25.2% for the period.

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