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Target’s Fiscal 2Q16 Cost Savings Efforts Helped Margin Growth

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Gross and operating margin highlights

Target’s (TGT) gross margin improved by ~50 basis points to 31.3% in fiscal 2Q16 from 30.9% in fiscal 2Q15. This was due to the sale of the pharmacy and clinic businesses to CVS Health (CVS), which contributed 70 basis points of improvement, combined with the company’s cost savings initiatives. This was partially offset by investments in promotions and increased shipping costs.

Target’s operating income margin also improved to 7.7% in 2Q16 from 7.6% in 2Q15. This was primarily due to continued positive merchandise mix, which was driven by strength in Signature Categories.

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Expense leverage and EBITDA margin

SG&A (selling, general, and administrative) expenses came in at 20.1% in 2Q16, compared to 19.9% in 2Q15. However, this was partially offset by the benefits from the sale of the company’s pharmacy and clinic businesses and continued expense discipline across the organization.

Target reported an EBITDA (earnings before interest, tax, depreciation, and amortization) margin of 11.2% in 2Q16, compared to 10.8% in 2Q15. Costco Wholesale (COST) still hasn’t released its fiscal 4Q16 results. Macy’s (M), Nordstrom (JWN), and Walmart (WMT) reported EBITDA margins of 10.8%, 10.5%, and 6.6%, respectively, over the same period.

Negative-to-flat comparable sales expected

Cautious consumer spending led to lower-than-expected sales for Target in fiscal 2Q16. As a result, Target expects comparable sales to be in the range of -2%–0% for both fiscal 3Q16 and 4Q16. This is consistent with its 2Q16 guidance. If comparable sales are in the midpoint of the range, then the company expects gross margin and SG&A expense rates to be similar to last year’s levels.

Target hasn’t provided any EBITDA guidance for the coming quarter. In contrast, Burlington Stores (BURL) expects its EBITDA margin to increase by 30–40 basis points during its 2Q16.

Target makes up 0.3% of the iShares S&P 100 ETF (OEF).[1. Updated on August 17, 2016.]

In the next part of this series, we’ll discuss Target’s stock performance after results and its valuation growth multiple.

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