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Why Target’s Fiscal 1Q17 Margins Contracted

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Price investments hurt margins

Target’s (TGT) muted margins performance in fiscal 1Q17 shouldn’t surprise investors. As expected, the company’s margins were negatively impacted by its increased investments in enhancing its digital capabilities and lower top-line performance. Plus, the company lowered prices to better compete with Walmart (WMT) and Amazon (AMZN), which further pressured margins in fiscal 1Q17.

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1Q17 margins

Target’s fiscal 1Q17 gross margin came in at 30.5%, a decrease of about 40 basis points when compared with fiscal 1Q16. The company’s increased price investment to support its “every day low prices” and higher digital fulfillment charges took a toll on its gross margin performance. In comparison, rival Walmart’s fiscal 1Q18 gross margin largely remained flat as benefits from increased top-line performance and procurement savings were offset by investments in price and a shift towards digital business. Meanwhile, Costco (COST), which is slated to report its fiscal 3Q17 earnings on May 25, is expected to report better margins driven by improved store traffic.

Target’s EBIT margins contracted 80 basis points to 7.4% during fiscal 1Q17, reflecting lower gross margin, higher SG&A (selling, general, and administrative) expenses as a percentage of sales, and an increased depreciation and amortization expense rate.

Outlook

Target’s margins are projected to contract in coming quarters as the company will continue to invest in strengthening its digital capabilities. Plus, deflationary pressures in the grocery segment will likely pressure margins more. For fiscal 2Q17, the company expects its EBIT to decline by about $200 million YoY, reflecting lower sales and higher SG&A expenses.

Investors seeking exposure to Target through ETFs can invest in the Oppenheimer Ultra Dividend Revenue ETF (RDIV), which has 5.4% of its total holdings in the company.

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