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Why Target’s Margins Could Stay Low in the First Quarter

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Updated

Recent performance

The profit margins of mass merchandisers including Target (TGT), Costco (COST), and Walmart (WMT) are under stress and have declined in the past several quarters. Their continued investments in growth measures including e-commerce expansion and value pricing are coming at the cost of margins.

These retailers have managed to drive traffic and defend their market share amid heightened competition from Amazon (AMZN) and other deep discounters. However, gross and operating margin continued to decline.

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During the last reported quarter, Target’s gross profit margin contracted 40 basis points to 25.7%, which reflected higher digital fulfillment and supply-chain costs. Meanwhile, its operating margin stayed flat as a decline in gross margins offset benefits from the lower SG&A expense rate.

In comparison, Walmart’s gross margins also remained weak and contracted on a YoY basis, reflecting investments in price, unfavorable mix, and higher transportation costs. Moreover, Costco’s value pricing continued to hurt its gross margin rate.

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Outlook

We expect Target’s gross profit margins to continue to decline in the first quarter, reflecting an increase in digital fulfillment costs owing to higher digital sales. Also, investments in growth initiatives and higher supply-chain costs are expected to remain a drag.

Target’s cost and productivity saving measures are expected to support operating margins. However, a lower gross margin rate is likely to offset the benefits and affect operating margin.

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