Target raises the alarm on discretionary spending

Target (TGT) reported disappointing Q3 earnings, missing analyst estimates on both revenue and EPS while lowering its full-year guidance. Adjusted EPS came in at $1.85, well below the consensus estimate of $2.30, and revenue rose 0.9% year-over-year to $25.23 billion, missing the expected $25.74 billion. Comparable sales grew just 0.3%, far below the 1.5% forecast, driven by a 2.4% increase in traffic but offset by a 2% decline in average transaction amount. Operating income fell 11% year-over-year to $1.17 billion, with an operating margin of 4.6%, significantly underperforming the 5.6% estimate.

The company faced profitability challenges, as its gross margin fell to 27.2%, missing the 28.7% estimate, due to higher digital fulfillment and supply chain costs. Target’s digital comparable sales were a bright spot, growing 10.8%, with strong performance in same-day delivery and Drive Up services. However, store comparable sales declined by 1.9%, highlighting challenges in brick-and-mortar operations. Key growth categories included beauty, which saw a 6% increase, and food and beverage, which grew modestly, but these gains were offset by weakness in discretionary categories like apparel, home goods, and hardlines.

Target lowered its full-year EPS guidance to $8.30-$8.90, down from $9.00-$9.70, citing weaker-than-expected Q3 results and a subdued outlook for Q4. For the fourth quarter, Target expects EPS between $1.85 and $2.45, below the consensus estimate of $2.65. The company anticipates flat comparable sales in Q4, reflecting continued softness in discretionary spending as consumers prioritize essentials amid economic pressures.

CEO Brian Cornell highlighted "unique challenges and cost pressures," including higher inventory management costs due to supply chain adjustments and elevated digital sales volume. Target also pulled forward holiday inventory to mitigate potential disruptions from East Coast port strikes, which impacted operational efficiency early in the quarter. While management noted that inventory levels rose just 3% year-over-year, they acknowledged lingering challenges in clearing higher-margin discretionary items.

Target’s results lagged significantly behind those of its peer Walmart (WMT), which reported stronger performance in general merchandise categories and raised its full-year guidance. Walmart’s market share gains among higher-income consumers further underscore Target’s struggles in maintaining its customer base in a competitive environment. Analysts noted that Target’s price gaps with Walmart, ranging between 4% and 5% for essential items, may be driving shoppers to Walmart for value offerings.

The earnings report reflects a broader challenge for Target in balancing its discretionary-heavy product mix with shifting consumer priorities. While digital growth and customer traffic provide some optimism, they have yet to translate into meaningful profitability gains. This dynamic contrasts with Walmart’s more diversified revenue streams from advertising and e-commerce, which have insulated it from similar pressures.

Target’s lowered guidance and downbeat tone for Q4 have sparked concerns about the company’s ability to rebound in the near term. Shares plunged nearly 17% premarket, reflecting investor disappointment and a shift in sentiment compared to its competitors. As economic uncertainty persists, Target’s reliance on discretionary categories could weigh further on performance, especially if consumers remain price-sensitive during the critical holiday season.

In summary, Target’s Q3 results underscore significant operational and competitive challenges. While digital and traffic growth are encouraging, the company’s inability to compete effectively with Walmart and others in pricing and non-discretionary categories remains a key headwind. With a reduced outlook for Q4 and full-year 2024, Target faces a tough road ahead as it seeks to stabilize margins and regain investor confidence.