Target Shares Attractive Despite Near-Term Pressures

Target Stock at a Glance

• Current Morningstar Fair Value Estimate: $167
• Target Stock Star Rating: 3 Stars
• Economic Moat Rating: None
• Moat Trend Rating: Negative

Target Earnings Update

Despite no-moat Target (TGT) shares’ low-teens percentage plunge in the wake of disappointing third-quarter earnings, our $167 per share valuation should not change materially, as we attribute the softness to near-term factors. Consequently, our long-term forecast remains intact (mid-single-digit yearly revenue growth, high-single-digit operating margins forecast on average). We see opportunity in the shares, as prevailing sentiment seems overly fixated on near-term woes.

Comparable sales rose 2.7%, near our estimate, but sales trends deteriorated as the quarter unfolded, with the last two weeks of the period (late October) especially soft. Target expects a low-single-digit percentage decline in fourth-quarter sales. The softening sales environment, intensifying consumer focus on promotions, and high levels of theft led profitability lower, to a 3.9% operating margin that trailed our 5% estimate. Management contemplates a wide range of margin outcomes for the fourth quarter, centered around 3%, and our 6.5% estimate should fall toward the new anchor point. A time value of money-related adjustment to our valuation should largely offset the impact of a softer near-term outlook.

Target saw sluggishness in its discretionary categories, with sales in home and hardlines categories down at mid-single-digit rates. By contrast, food and beverage rose at a low-double-digit rate and beauty and household essentials categories were up at a low-single-digit clip. We believe mix is a significant reason why Target’s results lagged those of wide-moat Walmart, which relies on essentials for a greater mix of sales. Around 60% of sales at Walmart’s U.S. namesake stores come from grocery with a sharp focus on everyday value (especially important to cash-strained consumers), while we believe roughly 40% of Target’s sales come from nondiscretionary categories. Encouragingly, Target saw unit market share gains in all its merchandising categories, which suggests its value proposition resonates.