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Morningstar | Despite an Iconic Brand, Competition Should Limit Target's Long-Term Profitability Potential

While Target boasts an iconic brand and a national network of convenient storefronts, we believe its standing is under threat from considerably more powerful rivals Amazon and Walmart. The company works to differentiate itself by offering signature categories (style, baby, kids, and wellness) that carry higher margins and faster growth rates than other areas of its business, currently representing one third of total sales. However, we believe this strategy is coming under pressure as consumers shift more to digital retail, where Target significantly lags its peers despite recent progress, generating just under $4 billion of sales annually through that channel versus $23-plus billion at Walmart and $60-plus billion for Amazon in North America. Additionally, Target is underindexed in grocery (a meaningful traffic driver) at roughly 15% of sales, paling in comparison with competitors that achieve 50% or more of sales from this category. Given the faster-turning nature of grocery items, we believe this also accounts for the gap in sales per square foot between Target at $300, Walmart at $430, and Costco at $1,100. The company has taken steps to improve its positioning by exiting its Canadian operations, selling its credit card portfolio, and divesting its pharmacy and clinic business. Within its core physical store channel, Target is focused on opening smaller-format locations in urban areas to cater to an untapped consumer group. While this is still a small part of the organization at present, representing just 2% of its total store base, we’re encouraged by its growth prospects of 30-50 units a year for the next three years. Additionally, as a means to bolster customer loyalty, the company is attempting to drive REDcard penetration (which now stands above 20% of sales), an important endeavor given that these customers tend to spend roughly double that of an average equivalent customer. However, to keep pace with rivals including Walmart, Costco, and Amazon, we believe the company needs to execute on its omnichannel presence, as customers who shop in more than one channel tend to spend a multiple of the amount that a customer who shops in only one channel expends.