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Morningstar | While Target's Digital Transformation Has Delivered Results, the Competitive Environment Is Intense

Target has adapted well to a fast-digitizing retail landscape, but we believe it faces an intensely competitive environment in which customers have negligible switching costs, exacting relentless pressure to elevate service levels while holding prices low. Without the scale of industry leaders Walmart and Amazon or the differentiated business models that characterize the moat-endowed defensive retailers we cover, we expect Target will remain vulnerable to the competitive onslaught.While the environment should remain challenged, we believe retail has an omnichannel future, with customers increasingly demanding fulfillment from a range of options (ship to home, delivery, click-and-collect, and in-store purchasing) that should benefit larger firms with dense store networks. We have a favorable view of the firm’s ambitious $7 billion 2017 plan to renovate its stores to serve as omnichannel fulfillment centers. Target should remain better positioned than its smaller rivals in the sector, using its cost leverage and meaningful private-label efforts.Still, Walmart and Amazon should define the space, driving prices lower as they deploy unparalleled scale in ways that we believe Target cannot match. With only around 20% of its sales coming from food (which generates recurring store traffic), we believe the bar is particularly high, as Target will have to continue to invest to remain at the top of shoppers’ minds. With customers increasingly starting product searches on digital properties owned by either Amazon or (particularly for non-Prime members) Walmart, we expect firms such as Target will have to compete on the two giants’ terms.Target’s store network is fairly developed, and while we expect its newer small-format stores to unlock markets that could not have otherwise supported a traditional unit (such as urban areas and college campuses), we suspect that growth will largely come from its existing footprint, particularly as its failed Canadian expansion should temper its appetite for international growth. This puts an even higher premium on execution, as Target will need to leverage costs to keep prices competitive with its larger peers.