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Why Target’s Profit Margins Could Remain Weak?

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Dec. 3 2018, Updated 1:25 p.m. ET

Higher digital fulfillment costs

We expect Target’s (TGT) profit margins to continue to remain weak during the fiscal fourth quarter as higher digital fulfillment costs arising from the increase in e-commerce sales is likely to play spoilsport. However, the rate of decline is expected to slow down sequentially. Retailers are investing in growth measures like pricing and e-commerce platform to defend their market share amid increased competition from Amazon (AMZN), which in turn is affecting their margins.

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As for Target, the company has expanded its online order fulfillment option, which in turn, is expected to hurt margins. Also, lower pricing could further pressure margins. However, supply-chain reinvention is expected to lower the per unit digital fulfillment costs, which could cushion its margins in the coming quarters.

Target’s margin performance so far this year

Target disappointed investors with its margins in the first nine months of fiscal 2018. Target’s gross margin contracted 20 basis points and ten basis points in the first and second quarter of fiscal 2018, respectively. Meanwhile, the rate of decline accelerated during the third quarter, where its gross margins fell by 90 basis points.

Weak gross margins took a toll a toll on operating margins, which declined by 90 basis points, 20 basis points, and 40 basis points during the first, second, and third quarter of 2018, respectively.

Peers, including Walmart (WMT) and Costco (COST), also reported weaker margins so far this year. Costco is investing price in widening its value gap with peers, which in turn, is affecting its profit margins. However, the company’s increased membership fee income and control on overhead costs continue to support its margins. Walmart, on the other hand, is witnessing pressure on profit margins owing to its low pricing and adverse mix.

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