Target's 3Q Results Hit the Bull's-Eye

This morning, Target (TGT) reported a top-line beat for its third-quarter results, with revenue of $17.61 billion (+2.1% year over year) coming in above consensus estimates of $17.57 billion. The company's earnings of $0.86 per share came in right in-line with consensus. As for guidance, the company sees fourth-quarter EPS of $1.48 to $1.58, straddling consensus of $1.54. Management positively narrowed its expectations for its FY15 EPS view to between $4.65 and $4.75 from between $4.60 and 4.75 (compared to consensus of $4.72).

Importantly, same-store sales growth in the quarter was up 1.9% year over year, at the high end of its 1% to 2% guidance range (issued last quarter) and above the Street's estimates for 1.8%. The strong performance was backed by 1.4% traffic growth and comps in signature categories of Style, Baby, Kids, and Wellness (which have been focus areas) grew more than 2.5x the company average.

Digital channel sales increased by 20% year over year, showing continued improvement from the company's dedicated efforts to continue to develop its online presence. As companies like Amazon (AMZN) continue to gain popularity, it is important for traditional brick-and-mortar retailers to maintain and grow their ecommerce business; TGT recognized this from the beginning and its foresight is paying off. Although the 20% gain was lower than the 30% plan management had laid out, digital channel sales still contributed 40 basis points overall to comps growth within the quarter. We would expect management to provide more color on the discrepancy throughout the call.

REDcard (TGT's branded credit/debit card) penetration also edged further, accounting for 22.3% of sales in the third quarter (20 basis points above the previous quarter and 130 bps higher vs. a year ago).

Gross margins for the quarter were 29.4% (down 10 bps from a year ago), but benefited from favorable merchandise mix. The slight decrease can be attributed to reimbursement pressures in Healthcare (recall, however, TGT will be selling its pharmacy business to CVS (CVS) ) and investments into the betterment of the company's quality and innovation in exclusive brands.

As for capital allocation, TGT returned a total of $1.29 billion to shareholders in the quarter, consisting of 12.1 million shares repurchased and $352 million of dividends (up 6.7% from a year ago). Investors continue to benefit from the company's 6.5% free-cash-flow yield and we don't expect this to change.

Overall, the company delivered a solid in-line quarter that didn't necessarily blow us away, but did show positive trends. More specifically, it is encouraging to see Target fight off the "guilty by association" tag burdening the stock ever since the poor performances from Macy's (M) and Nordstrom (JWN) . TGT has roughly a 20% apparel product mix, so while there had been some speculation that it could be affected by similar apparel trends, the company ultimately slogged on.

That being said, note that TGT will inevitably be compared not only to Wal-Mart (WMT) but also to Lowe's (LOW) and Home Depot (HD) , as is the nature of the beast when you have a diversified business. All of these names beat expectations to a higher degree, so while TGT certainly did better than the apparel-focused department stores and provided an optimistic outlook, it has become clear that the home-improvement stores have raised the bar.

All in, we believe Target did enough to climb higher in the tough retail environment, especially given the upside over consensus in guidance. In this volatile market, we ultimately believe the company's consistent results will emerge as a driver for share gains (and we believe that CEO Brian Cornell will focus on this on the conference call at 10:30 a.m. ET). The call will be abundantly important for TGT so it can provide more commentary on its outlook and momentum in the business. We will also be listening for an update on the CVS deal and details on comps expectations for the rest of the year. We expect there will be questions regarding the tough apparel environment and how management plans to stay ahead of the curve.

Regards,

Jim Cramer, Portfolio Manager & Jack Mohr, Director of Research - Action Alerts PLUS

DISCLOSURE: At the time of publication, Action Alerts PLUSwas long TGT.