Dive Brief:

• Target shares dropped 10% Tuesday morning as the company reported mixed results in its third quarter earnings report. The company reported $1.09 earnings per share, missing analyst expectations of $1.12. The earnings, however, were up 20% year-over-year.
• The company’s revenue slightly topped analyst estimates at $17.82 billion, up 5.6% from last year while same-store sales grew 5.1% — the company's strongest same-store sales growth in 13 years. Target said its digital sales grew 49%, showing a payoff in its e-commerce push.
• Target's gross margin rate dropped 28.7% from 29.6% a year ago. The company attributed this drop to higher supply chain costs as the company tries to meet demands from online orders ahead of the holiday season while increasing in holiday-related inventory compared to last year.

Dive Insight:

Target’s focus on e-commerce fulfillment and store renovations might be driving in traffic, but it’s hurting its bottom line. CEO Brian Cornell has faith, however, that it will be able to deliver profitable growth beginning next year and so do analysts.

“Target’s Q3 results reflect the continued favorable impact of its multi-year investment strategy, with impressive sales growth both in stores and online, with minimal negative impact on margins, indicating leveraging of these investments,” stated Moody’s Lead Retail Analyst Charlie O’Shea in an email. 

Target has been funneling money into its e-commerce division to be more competitive with rivals Walmart and Amazon. The retailer has been building on its $550 million Shipt acquisition, adding same-day delivery to hundreds of locations in an effort to bring all 1,800 stores online by the end of this year. The company also continues to expand its Drive Up in-store pickup program to 1,000 stores before the holidays, and recently began offering free two-day shipping during the holiday season. 

Target's store traffic rose a healthy 5.3% during the quarter, reflecting the impact of updated stores, Cornell said during the company's earnings call this morning. Toy sales were also a strong point for the company, he said. In the wake of Toys R Us bankruptcy earlier this year, Target has added new toy lines and built out departments in 500 stores. One hundred stores feature large toy displays with interactive experiences.

Grocery sales, meanwhile, have not been as robust for Target, though the company is working to improve its assortment. It's been testing a sustainable sushi line by Hana Group, offering new wine and beer selections and expanding its organic and fresh offerings. Furthermore, the company has made improvements in its supply chain so perishables are fresher and delivered quicker.

“While we are satisfied with the progress Target has made in refreshing its food department we do not believe its ambition in non-food is reflected in its food offer," Neil Saunders, managing director of GlobalData Retail, wrote in an emailed note. "Much more effort is needed in developing new ranges, especially in prepared foods, and in creating more of a destination appeal to its grocery department. At the moment, Target's food offer is OK — but it needs to be better than OK if it is to generate superior growth."

Target's investment in store updates and in small stores is expensive, but this should drive traffic and sales in the future. During the third quarter, the company completed 140 store remodels and opened 12 new small-format stores. “In our view, as the new format is rolled out to more stores over the next year, it should provide some uplift to store sales —  growth which will be useful as Target starts to lap tougher comparatives,” said Saunders. 

The company’s refresh program, which improves the in-store experience and conversion rates in categories like beauty and apparel, drove sales gains for the quarter, according to Saunders.

Although the retailer’s gross margin fell, it’s a sign the company is reinvesting in itself to go head to head with competition — most notably Amazon and Walmart.

“As Target heads into the holidays, it does so in extremely good shape," noted Saunders. "These results are a testament to that fact. The 5.7% uplift in total sales is slightly softer than last quarter, but it is still a market-beating number and shows that Target is gaining share across many categories."