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Why Target’s Hot Deals Could Hurt Margins

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Part 2
Why Target’s Hot Deals Could Hurt Margins PART 2 OF 4

Why Target’s Margins Could Be at Risk

Lower prices and increased costs to hurt margins

Grocery retailers are lowering prices and adopting technologies to attract shoppers and compete better with deep-discounters, including Aldi and Lidl and online rival Amazon (AMZN), which recently announced price cuts after merging with Whole Foods. However, the price war among retailers is chipping away profits for grocery retailers. Investors are dumping grocery stocks, erasing billions of dollars from their market caps.

Target’s (TGT) margins are likely to take a hit from the proposed lower prices and increased costs associated with digital fulfillment. The company’s margins took a beating in the past three quarters despite reporting an improvement in sales as higher costs and cutbacks on promotions hurt profitability.

Why Target’s Margins Could Be at Risk

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In fiscal 2Q17,  the company’s gross margin fell by 40 basis points, and lower prices and a rise in digital fulfillment costs more than offset the benefits of sales leverage and cost savings. Meanwhile, the company’s EBIT (earnings before interest and taxes) margins fell by 90 basis points.

Outlook

Target’s margins are projected to fall in the near term. Cutting back prices and investments in the business’s digital arm are expected to hurt profitability. Target’s management stated on the fiscal 2Q17 conference call that they expect fiscal 3Q17 EBIT to fall by $230 million YoY (year-over-year), reflecting higher costs, lower pricing, and increased investments in growth initiatives.

How competitors are placed

Walmart (WMT) and Kroger’s (KR) margins are also expected to remain soft. Lower pricing to drive store traffic amid increased competition and business investments to strengthen the e-commerce arm is likely to offset the benefits stemming from cost savings and productivity measures.

However, Costco Wholesale’s (COST) margins are projected to improve on higher sales. Meanwhile, the company’s strong membership fee revenue and increased savings from the shift to the new Citi Visa co-brand card program are expected to fund most of the company’s growth initiatives without hampering margins.

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