Tempering Our Short-Term Expectations for Target

With third-quarter profitability hindered by supply chain and digital order fulfillment costs, we plan to trim our $71 per share valuation for no-moat

Target posted 5% comparable sales growth for the quarter and year to date. Digital sales led growth (49% for the quarter) but weighed on margins (as did a pre-holiday inventory build-up), leading to a 4.6% third-quarter operating margin (5.7% year to date), versus 5.0% in fiscal 2017's third quarter. Management left its fiscal 2018 adjusted EPS guidance at $5.30 to $5.50; our $5.41 pre-announcement mark does not include $0.07 of third-quarter tax-related adjustments, effectively leaving our estimate near the low end of management's forecast.

We have a favorable view of Target's rapid drive-up expansion, which allows customers to pick up orders placed online in the store, particularly given management's estimate that many of the transactions are either incremental or in lieu of (more expensive to fulfill) shipment to home. We believe management's citation of unexpectedly high digital growth as a reason for third-quarter margin compression reinforces our view that Target can best compete in a changing retail world with a robust combination of omnichannel fulfillment options that leverage its store base. Although we do not believe the firm's competitive standing benefits from an economic moat, we believe Target can deliver performance by capitalizing on the convenience and fulfillment economics provided by its well-located store network (including its growing small-format roster in urban areas).

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