Continued Headwinds Reduce Target's Appeal

We don’t expect a material change to our $74 fair value estimate for

Even with the mid-single-digit retreat in the share price, we’d suggest investors await a more attractive risk/reward opportunity, given the continued headwinds for Target. We believe Target possesses a well-known brand, convenient locations, and considerable scale; however, its product mix skews toward categories that go head to head with Amazon. Further, at $2.5 billion in 2015, digital sales accounted for just 3.5% of Target’s total sales base, and as such, the firm lacks a cost edge to defend itself against established online competitors (Wal-Mart generates more than $13 billion in online sales and Amazon generates more than $100 billion), supporting our no-moat rating.

Although digital channel sales increased 16% on top of a 30% jump in last year’s second quarter (reflecting a 0.5% comp), this growth is coming off a very low base. Target’s same-store sales (excluding digital) slipped 1.6%, as the retailer has fallen victim to the challenges experienced across the sector. Traffic slumped 2.2%, with particular weakness in electronics and grocery, while prices increased 2.6% and units per transaction ticked down 0.5%. To offset these pressures, Target will probably need to cut prices to drive traffic if sales growth remains persistently low, resulting in negative operating leverage and margin contraction.

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