Brian Cornell of Target

Target Corp. saw its shares leap 4.6 percent Wednesday after the company raised its outlook for the fourth quarter.

The retailer’s shares rose 4.6 percent to $76.03 despite a drop in sales and comps. Target raised its expectations for fourth-quarter comps to the range of a 1 percent decline to 1 percent gain, compared with prior guidance of a 2 percent drop to flat comps. The retailer for the fourth quarter expects earnings per share of $1.55 to $1.75.

For full-year 2016, Target now expects EPS in the range of $4.67 to $4.87, compared with prior guidance of $4.36 to 4.76.

Target’s earnings in the third quarter improved 10.7 percent to $608 million from $549 million in the 2015 period, but sales and traffic continue to suffer.

“Our first priority is to grow traffic and comp sales,” said Brian Cornell, chairman and chief executive officer. “The flat comps for the first nine months of the year are well below our expectations. We believe we can achieve sustainable top- and bottom-line growth over time.”

The retailer faces a brutally competitive holiday season and deflation in the food category has been impacting all mass retailers, although food accounts for only 20 percent of Target’s total sales compared to 55 percent at Wal-Mart Stores Inc.

“We saw another small decline in food in the third quarter due to deflation,” said Cornell. “We’re focused on delivering stronger growth in food.”

Sales in the third quarter ended Oct. 29 declined 6.7 percent to $16.4 billion from $17.3 billion in last year’s third quarter, while comps fell 0.2 percent, near the high end of the retailer’s guidance of flat to down 2 percent.

Adjusted EPS rose 22.1 percent to $1.04 in this year’s quarter from 86 cents per share in 2015, surpassing Wall Street estimates of 83 cents a share. Cornell noted that Target’s EPS has grown more than 3 percent in the first three quarters of 2016 in spite of flat comp-store sales growth.

Segment earnings before interest expense and income taxes, which is Target’s measure of segment profit, were $1.06 billion in the third quarter, an increase of 9.9 percent from $962 million in 2015.

Third-quarter earnings before interest, taxes, depreciation and amortization and earnings before interest and taxes margin rates were 9.9 percent and 6.4 percent, respectively, compared with 8.6 percent and 5.5 percent, respectively, in 2015. Third-quarter gross margin rate was 30.2 percent, compared with 29.4 percent in 2015, reflecting the benefit of the sale of Target’s pharmacy and clinic businesses and strength in signature categories. “Sales in signature categories out-comped by three percentage points sales of non-signature categories,” Cornell said.

Third-quarter sales were driven by back-to-school and back-to-college. Denim was singled out as a top performer, driven by new fashion and fits for adults and kids. Home saw a double-digit increase in digital sales.

The selling, general and administrative expense rate for the third quarter was 20.3 percent in 2016, compared with 20.7 percent in 2015, reflecting continued expense discipline across the organization.

Cornell said the third quarter reflects “meaningful improvement in our traffic and sales trends and much stronger-than-expected profitability. Favorable gross margin mix and efficient execution by our team drove third-quarter EPS well beyond our guidance.”

Target last year launched a comprehensive cost-savings effort with the goal of taking $2 billion out of the company’s expenses. Cornell said Target exceeded the $2 billion goal and will continue to look for additional opportunities for cost-cutting.

Smaller, flexible-format stores are showing strong performance, he said. “We opened five in the third quarter, including our TriBeCa store. When we open, we go beyond legacy systems, personalizing the environments,” Cornell said. “We’re now operating 30 of these stores and we increasingly see the opportunity of operating hundreds of flexible format stores over time. For moving into densely populated urban centers or college campuses, this is a critical growth vehicle.”

Digital sales rose 26 percent and contributed 0.7 percentage points to comparable sales growth. Year-to-date, digital sales are up by 20 percent.

Cornell said Target has “devoted capital and experience” toward improving the digital functionality and made a reference to past glitches during high-volume periods, including Cyber Monday of 2015. “We ran a promotion that allowed us to stress-test our systems,” Cornell said. “We offered 10 percent off our entire assortment both in-store and online. The digital comp was particularly high on that day. Our systems performed very well, as we prepare for even greater traffic.”

Comps in electronics and entertainment outperformed the company average in the third quarter, which bodes well for the holiday period.

“We feel very good about our plans for the fourth quarter,” Cornell added. “In entertainment, we have a combination of new, exclusive items and items that are on-trend. We’ve had a great reaction to our toy and gifting catalogues. Those categories trended downward in Q3, but we’re in a good position for Q4.”

Cornell said Target’s “Expect More, Pay Less,” tag line may be in need of a tweak. “With our signature categories performing [strongly], we continue to deliver on the ‘expect more’ side. Early this year, we fell short on ‘pay less’ and value side. We’re communicating value more clearly now.”

Cornell is watching Amazon with a degree of fascination and trepidation. He said working on the value side of the equation and addressing fill-in guests will position the retailer for success. “The strategy we have allows us to be very competitive and will allow us to win in the current retail environment,” he said.

Noting that more than 90 percent of all retail shopping takes place in physical stores — a slight jab at Amazon — Cornell said Target’s investments in elevating the store experience will pay off with shoppers. “We’re combining that with outstanding merchandise and value,” he said. “In addition, we’re giving guests the choice of shopping any way they want. We’re building out capabilities and leveraging stores as flexible fulfillment centers. We’re using stores to deliver the last mile. It’s a huge competitive advantage.”

For example, last year, 460 stores were able to ship directly to customers. This year, Target extended the service to another 600 stores, so more than 1,000 stores that will be shipping one-third of the company’s digital volume from Thanksgiving through the holiday season.

 

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