Target's Long-Term Prospects Are Murky

No-moat Target TGT posted exceptional third-quarter results that should lead us to increase our $82 fair value estimate by a high-single-digit percentage. While its omnichannel investments and refreshed stores have delivered excellent results through fiscal 2019, we are more circumspect about its long-term prospects amid intense competition. We still expect low-single-digit sales growth against mid-single-digit adjusted operating margins on average over the next decade. With shares up more than 10% after the earnings report, we suggest investors await a more attractive entry point, as we believe sentiment does not adequately reflect the long-term competitive challenge.

Target saw 4.5% quarterly comparable sales expansion (beating our 3.3% mark), driven by 2.8% growth in stores and a 31% uptick in digital. With its operating margin up 80 basis points (to 5.4%, ahead of our 4.8% expectation on efficiency efforts and strong category and fulfillment mix), management lifted its fiscal 2019 adjusted EPS guidance to $6.25 to $6.45 from $5.90 to $6.20. We expected $6.18.

We attribute recent outperformance, including roughly 10% two-year comparable sales growth, to factors that include Target’s well-executed expansion of digital fulfillment capabilities, refreshed stores that are better suited to serve as omnichannel hubs, the opening of smaller-format locations, and efficiency efforts. However, while we will increase our outlook for fiscal 2019 and 2020 (expecting ongoing momentum), we are skeptical about Target’s long-term prospects as competition intensifies in a sector with few switching costs. After benefits from recent factors like store remodels, which have provided an unexpectedly persistent comparable sales lift and added more than expected to the top line, and catch-up investments to overcome prior management’s relative lack of attention to e-commerce recede, we believe Target will face relentless price pressure that should limit its long-term potential.

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