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Target Corp oversold – J.P. Morgan

Target Corp's solid sales numbers suggest it could achieve the high end of its Q4 guidance

For the first time since chief executive Brian Cornell took over in August 2014, Target Corp. failed to beat earnings expectations and reported a year-over-year decline in gross margins.

This has investors wondering whether the retail giant’s upward earnings revision cycle is running out of steam, and if its turnaround efforts are finally putting pressure on margins.

Target shares fell more than four per cent on Wednesday following the release of its third quarter results, but J.P. Morgan analyst Christopher Horvers thinks that presents a near-term buying opportunity.

“In our view, there were several positives that should not be overlooked,” he told clients.

That included a 30 basis point acceleration in Q3 traffic, and an overall 40 bps acceleration in comparable sales as October was in line with Target’s quarterly average, unlike most other retailers that have seen slowing sales as a result of the weather. General and administrative expense savings are also running ahead of expectations.

Horvers pointed out that Target’s solid sales numbers suggest it could achieve the high end of its Q4 guidance as a result of ongoing turnaround efforts.

He also noted that Target’s deal to sell its pharmacy business to CVS Health Corp. may allow it to recapture 15 to 20 bps of gross margin headwinds from pharmacy reimbursements.

The stock also offers a dividend yield of about 3.1 per cent, which the analyst believes provides downside protection ahead of dividend  increases in the next couple of years.

“Retail is broadly oversold with our thesis that the macro remains fine (not a consumer recession) bolstering a catch up in Target,” Horver said. “Indeed, the solid comps at Home Depot, Lowe’s, Wal-Mart and Target indicate that the consumer is in decent share and the weakness in apparel is likely a function of secular and weather pressures.”

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