Will Digital Sales Save Target's Holiday Quarter?

By Markets Fool.com


Image source: Target.

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The number of people walking into Target (NYSE: TGT) stores during the third quarter improved about 1% from the second quarter. While foot traffic is moving in the right direction for Target, the real driver of its comparable-store sales is its website. Digital sales climbed 26% year over year last quarter, an acceleration from the second quarter.

Overall, digital sales contributed 70 basis points to Target's comparable-store sales. Without the digital growth, comparable-store sales would have declined 0.5%. In the fourth quarter, Target will come up against a tough comparable growth number. Last year, Target grew its online sales 34%.

Target's management provided an improved outlook for the fourth quarter. Executing on digital sales will undoubtedly play a large part in meeting those expectations. Here's what investors can expect.

The improved outlook

Management raised its outlook for comparable-store sales by 1 percentage point to a range of -1% to 1%. It still expects an overall decline in sales of around 3% due to the removal of pharmacy sales. Management also raised its earnings guidance based on its early debt retirement and resolving income tax matters.

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Even with foot traffic on the upswing, total transactions declined in the third quarter. The number of checkouts at Target declined 1.2%, but was offset by a 1% increase in average ticket. The increase in ticket price is due to a mix shift in purchases and pricing -- groceries are down and home goods are up.

The impact of that shift puts additional pressure on Target's online sales. Groceries certainly make up a smaller portion of Target's online sales, and it's quickly falling behind competitors like Wal-Mart (NYSE: WMT) and Amazon.com (NASDAQ: AMZN) in the area. Target's digital channels will have to outperform those competitors in apparel and home -- a tall task.

During Target's earnings call, COO John Mulligan noted that "digital is going to be an important part of our growth strategy going forward. ... We're winning during key seasons and we certainly expect that to be a key driver to our fourth-quarter success."

What Target is doing to improve digital sales

Target is taking several initiatives to ensure it maximizes revenue from its digital channels in the fourth quarter.

During the third quarter, it ran a one-day 10% off everything promotion to stress-test its website. Last year, Target's website experienced intermittent downtime on Cyber Monday. Management says the system performed well during the test and provided valuable insight for the upcoming holiday season.

Additionally, Target has invested heavily in improving its supply chain and fulfilling orders through its in-store inventory. Management says that it expects its new algorithms to help it remain well-stocked in stores and online despite actually carrying less inventory. Over 1,000 stores will fulfill and ship online orders this year, up from 460 last year. The move should ensure Target doesn't miss out on online sales due to items being out of stock or having long shipping estimates.

Of course, the competition isn't standing still. Wal-Mart acquired Jet.com last quarter, and it plans to use the e-commerce website and the management team behind it to accelerate its online sales growth. Wal-Mart will benefit from combining its fulfillment network with Jet's, and Jet.com could see sales surge with access to Wal-Mart's product assortment and scale in shipping.

Meanwhile, Amazon opened 18 new fulfillment centers in the third quarter and five more in the first few weeks of the fourth quarter as it gears up for high holiday sales expectations. The added capacity is mostly to support its Fulfilled by Amazon program, which stores inventory for third-party vendors. The program had a significant impact on its fulfillment expense in the fourth quarter last year, and Amazon responded by investing heavily in capacity this year in preparation to cut down on costs in the long term.

Target's improved outlook for its comparable sales and earnings will come under pressure if it faces any setbacks in sales through its digital channels. With intense online competition and a tough comparable quarter from last year, Target may see its two-quarter streak of accelerating online sales growth come to an end this quarter. Investors should pay attention to Target's results from Black Friday and Cyber Monday to get a sense of how it's performing against the online competition, and what kind of impact it could have on its overall sales results.

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