Target's conservative profit outlook for holidays sends shares tumbling

Target CEO Brian Cornell is full of confidence heading into the holiday season, but investors showed more concern Wednesday about how the investments in price rollbacks, boosting employee wages, and the higher costs to fulfill digital orders will continue to take a toll on the retailer's profits.

The Minneapolis-based company's shares fell nearly 10 percent Wednesday after Target released a more conservative profit guidance for the fourth quarter than investors were expecting.

The stock tumble was a striking contrast to the optimism Cornell expressed Wednesday about the momentum Target has built going into the holidays. The retailer, he said, has had two consecutive quarters of traffic and sales growth and with efforts in store remodels, new brands, and new urban stores paying off as much as, if not more than, the company expected.

Cornell used the term "confidence" or "confident" at least eight times on a conference call with analysts in which he was peppered with questions about the pressure on profits.

"While the fourth quarter is always intensively competitive, we're entering this holiday season with lots of confidence enabled by this year's investments and the tireless efforts of our team," he said.

Target forecast fourth-quarter comparable sales as flat to up 2 percent. The part that really disappointed investors was a lower-than-expected outlook range for adjusted earnings per share of between $1.05 to $1.25, when analysts were expecting $1.24.

Brian Yarbrough, an analyst with Edward Jones, said that while Target managed to post solid results in the third quarter, investors are worried about how the acceleration in store remodels next year and the continued pressure from the price rollbacks will continue to drag down the bottom line.

"I think people are really concerned about 2018," he said. "We've seen this multiple times across retail when these companies talk about any type of margin pressure, people get so scared about Amazon."

As if on cue, also on Wednesday, an announcement from Amazon about lowering prices on Thanksgiving-related food items at Whole Foods and the promise of more reductions to come sent some grocery retailers' stocks down.

As it has struggled with competition from Amazon and Walmart, Target has positioned this year to be a rebuilding year for the company as it recovers from a yearlong sales slump that it finally pulled out of over the summer.

It is investing $7 billion over the next few years in various initiatives to revive its sputtering business and is taking a hit to margins this year as it has rolled back prices as part of a campaign to better compete with Walmart.

This year, Target has remodeled about 110 stores, opened about 32 new small-format stores, launched eight new exclusive brands and upgraded its technology and supply chain. It is planning to step up some of those initiatives next year with 325 store remodels on tap and at least 35 new store openings.

In October, Target also boosted the wages of its hourly employees to $11 an hour, in an effort to recruit and retain more workers and improve customer service. But that is also an added expense that will continue into next year — and in the coming years as it plans to increase wages to $15 an hour by 2020.

Neil Saunders, managing director of GlobalData Retail, said Target is moving in the right direction, albeit at a slow pace and requiring significant costs.

"It is a fact that no retailer of Target's scale and size can implement a quick turnaround in today's retail market," he wrote in a research note. "The process of reinvention takes time, effort and money — all of which have to be expended before any eventual rewards are reaped."

In a call with reporters, Cornell emphasized that the new initiatives are worth it.

"Those investments are driving traffic and driving market share gains," he said.

In the August-to-October quarter, Target said comparable sales rose 0.9 percent, helped by an increase in store traffic but mostly driven by a 24 percent jump in online sales.

Its overall revenue in the third quarter was better than expected, increasing 1.4 percent to $16.7 billion, up from $16.4 billion from the same quarter a year ago, as Target benefited from the extra sales of new stores it opened this year.

Its quarterly profit dropped 21 percent to $480 million, or 88 cents a share, compared with $608 million, or $1.07 a share, in the same period a year ago. When adjusted for one-time charges, it earned 91 cents a share, which was better than the 86 cents analysts were expecting.

Sales were particularly strong in electronics, which saw double-digit growth helped by new phone launches and the Nintendo Switch.

But apparel sales, which typically have higher margins and have been a strength for Target, softened in the quarter even with the launch of three new apparel brands — A New Day in women's apparel; Goodfellow & Co. for men; and women's athletic leisure line JoyLab.

Cornell said the reception to the new brands has been "tremendous" and the company gained market share in the category, but he blamed the dip on the warm fall weather, similar to what other department stores chains have said in recent weeks.

A bright spot was that Target finally saw growth in food and beverages, which had been a drag. Executives said the stronger performance came in produce, where they have been working to improve availability and freshness, and in adult beverages such as beer and wine.

And executives said they saw a strong response to the launch last week of Hearth & Hand, a new home decor line that is part of a multiyear partnership with HGTV stars Chip and Joanna Gaines. They hope it will continue through the holidays and are working to quickly replenish items that have already sold through.

The stock closed at $54.16 a share, down $5.93.

Kavita Kumar • 612-673-4113