Target Earnings: Short-Term Pain, Long-Term Gain

(Bloomberg Gadfly) -- There was much to cheer in Target Corp.'s third-quarter earnings results. It delivered comparable sales growth for the second consecutive quarter, thanks to a healthy 1.4 percent increase in traffic compared to the same period last year.

Target Earnings: Short-Term Pain, Long-Term Gain

And yet investors sent the shares down, likely because they were more focused on other numbers in Thursday's report: Namely, that net income fell 21 percent from a year earlier. And even as CEO Brian Cornell declared in a press release that his team is "very confident" in its holiday season plans, Target's earnings forecast for the fourth quarter wasn't as upbeat as investors had hoped.

But if you take a long-term view of Target's prospects, it's hard to be overly concerned about this hit to profitability. And that's because the big-box store is spending money on the right things. 

In part, Target's profit was crimped in the quarter because it remodeled 37 stores, a step in an ongoing effort to revamp more than 1,000 locations by 2020. For a retailer that in the latest quarter drew 96 percent of its sales from brick-and-mortar stores, it's hard to argue against spiffing up its fleet.

Meanwhile, it also raised its minimum wage to $11 per hour in October. With a tighter labor market and competitors such as Wal-Mart Stores Inc. having long ago bumped up their wage floors, this is a smart way to attract and retain workers. 

Still more profit pressure came from lowering prices on everyday essentials. There were signs this helped Target in key ways in the quarter. Executives said they saw a "meaningful" increase in sales at regular price in the quarter, along with an increase in customers making shorter, quicker, "fill-in" trips. That suggests the price cuts are helping get shoppers in the door. 

Target Earnings: Short-Term Pain, Long-Term Gain

And finally, fulfillment costs for online orders also weighed on profitability. But that's not such a bad thing, as it's a byproduct of growing e-commerce sales.  

Target Earnings: Short-Term Pain, Long-Term Gain

All of this is to say that the parallel universe in which Target does not take these profit-eating steps is much worse for the company. Would investors rather that customer service suffered at Target because it didn't pay people competitively? Would they prefer that Target let its stores spiral into dumpiness? (Just look at how disastrously that has worked out for Sears Holdings Corp.)

It is prudent to incur this short-term pain, especially when you consider the other things Target has going for it.

Its investment in developing new private brands is paying off. Its Cat & Jack kids-clothing line is a big success. And it has been encouraged by early sales of Goodfellow & Co., its new menswear line, and Hearth and Hand with Magnolia, a home-goods line created in partnership with HGTV stars Chip and Joanna Gaines. Margins tend to be relatively high on private brands, so it's promising that Target seems to be scoring with these launches.

And executives said they saw double-digit increases in comparable sales in the adult beverage category from the same period last year. This is noteworthy because it's one of the store areas where Target's remodeling spending is most apparent. Wine, for example, is now presented in sleek-looking wooden crates that give the department a more upscale feel. This offers evidence the money it's spending on making stores look better can help with top-line sales.

Also, let's take a moment to breathe a sigh of relief about what we didn't hear from Target. In recent quarters, it has sometimes chalked up its challenges to a choppy consumer environment -- an explanation that felt a bit like an excuse when consumer sentiment has generally been strong. But that was not mentioned as a headwind on Thursday, suggesting the retailer sees more sustained strength across varied geographic markets.

Overall, Target is looking like a better business today than it did six months ago -- even if investors aren't giving them credit for it at this moment.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Sarah Halzack is a Bloomberg Gadfly columnist covering the consumer and retail industries. She was previously a national retail reporter for the Washington Post.

To contact the author of this story: Sarah Halzack in Washington at shalzack@bloomberg.net.

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