Home, Apparel Categories Punish Target in 3Q

Minneapolis — The sluggish performance in home and apparel were entirely to blame for Target Corp.'s gross margin rate drop in the third quarter, the 1,591-unit retailer said during its earnings call – and Target shoppers are avoiding collection-level home textiles in favor of bedding basics.

"Apparel and home represented a lower portion of our sales this year than last year," said Douglas Scovanner, evp and cfo. "Slower growth in those categories was responsible for all for the decline in gross margin rate."

Scovanner noted that, on average over the past decade or so, Target's lower margin businesses have grown at a faster pace than its higher margin businesses, like home and apparel.

"All of the gross margin rate deterioration in the third quarter was mix related, so the mix issue in Q3 this year was clearly the most significant mix-effected quarter that we've had in many, many, many, years, running about triple the adverse mix effect of the average quarter," he continued.

Target reported third-quarter net earnings of $483 million, down 4.5% from $506 million in the year-ago period, and Wall Street responded by pushing down the share price more than 6% the day of the announcement, Nov. 20. Gross margin rate as a percentage of sales dropped off 40 basis points to 34.1%.

Sales climbed 9.3% to $14.8 billion, with comps cruising up 3.7%.

Home specifically had been performing "pretty well" recently for Target until the third quarter, when "it softened up a bit" — a trend the retailer sees persisting into the new year, said Gregg Steinhafel, president. "We expect that to remain somewhat soft until some of the housing issues go away or at least diminish in terms of magnitude," he added.

That means at least into the fourth quarter and likely into the second quarter of 2008, Steinhafel said, "We expect the soft sales environment to continue and that the discretionary categories like apparel and home will be under more pressure than the hard lines and food categories."

In preparation for this, Target has "pulled back our receipts in those businesses to reflect rates of sale that will be more modest than we've experienced in the past," he said.

While the fourth quarter is projected to be a time of further deterioration in the sales mix, it is expected to be at a lesser degree than the discount chain experienced in the third quarter.

Apparel has already been aided by normalizing weather conditions and a consumers' willingness to trade up, Steinhafel said. The same dynamics are true in hand lines and food.

But home has seen instead a "trade-down," Steinhafel said, citing as an example stronger selling lately for basic bedding vs. "collection bedding" programs.

"More of the trade-down is happening in the home, but the balance of the business, we don't see any trade-down whatsoever," he said.

As cost pressures related to global issues — especially the rising price of petroleum and related goods — mount, Target said it is already finding its customer base responsive to the higher tickets it has tested in areas like hard lines, such as plastic storage.

"We're experiencing cost pressures right now that will manifest in the first and second quarter — both domestic and international," Steinhafel said. "In past year or two we have been able to pass along these cost increases in the form of higher prices. The marketplace has been receptive to that, and we hope that that kind of activity continues into '08."

Target.com, which had been having a "very good year" so far, was another area that slowed during the third quarter as "our sales rates of increase have moderated somewhat compared to very robust increases we were seeing in the early parts of the year," Steinhafel said.

The company also authorized a new $10 billion share repurchase program, replacing the previous authorization.