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Target's $7 billion spending plan still leaves some question marks

It's Target's turn to feel the pain.

Nearly a year and a half after Wal-Mart said investments into its stores and employees would dramatically cut into its profits, a similar announcement from Target on Tuesday garnered the same reaction on Wall Street.

After CEO Brian Cornell outlined plans for the company to spend $7 billion in cash over the next three years — and forfeit $1 billion in annual operating profit as it lowers prices and invests in stores — the retailer's shares had their worst day since 2008.

The sell-off mimicked the one experienced by Wal-Mart in October 2015, when its stock recorded its steepest daily decline in 27 years. It also underscored how much less patient investors can be when bricks-and-mortar retailer invest in their businesses versus online players like Amazon.

Yet while investors seemed skeptical about Target's plans, punishing its shares by more than 12 percent, analysts agreed the company is making the right investments for the long term. That doesn't mean, however, that all of its lingering issues have been solved, as traffic and the grocery business remain critical headwinds for the retailer.

"What they're doing is right, but the devil of the details is always going to be in the execution," Craig Johnson, president of Customer Growth Partners, told CNBC. "The jury's still out as to whether they have a detailed plan to build back traffic."

While many of its competitors are shuttering locations, Target is dialing up its investments in its existing stores. The company plans to renovate some 600 stores over the next three years, including a more elevated presentation of its apparel offerings. Some of these stores haven't been upgraded in a decade, Cornell said.

"We can't capture that market share if we're presenting an old, tired store," the CEO said.

A shopper during Black Friday at a Target store in Chicago.
Jim Young | Reuters
A shopper during Black Friday at a Target store in Chicago.

Meanwhile, Target will accelerate the rollout of its small-format stores that allow it to enter dense urban markets. While these stores carry a higher price tag than its rural, big-box locations, they deliver two times the sales productivity as the average store in its fleet, Cornell said.

Importantly, they also serve as another distribution hub for the company's online orders, Moody's analyst Charlie O'Shea said.

Target's other planned investments into the supply chain and private label brands also seem logical, as it grows online sales and looks to differentiate its product, O'Shea said. While there's always a risk in creating new brands — particularly as Target is banking on 12 labels to add more than $10 billion in sales over two years — they should help bring traffic into Target stores, O'Shea said.

The retailer's Cat & Jack children's brand, which launched in July, is on pace to reach $1 billion in sales in one year, Cornell said.

Still, several challenges remain. Traffic in Target stores has been weak for several quarters, as its decision to sell the pharmacy business to CVS reduced the number of repeat visits to its shops. That's because shoppers have been reluctant or slow to switch their prescriptions over.

While Cornell said traffic to its pharmacies has improved in recent quarters, it's facing stiffer competition from Wal-Mart. What's more, CVS was recently cut out of deals that competitor Walgreens made with pharmacy benefits managers, which are expected to result in more than 40 million lost prescriptions.

Meanwhile, Target's grocery department continues to be a point of weakness. Though Cornell said the company is not standing idly by when it comes to the category, it's been slow to roll out visible changes. The CEO added that it's not in Target's DNA to be a full-service grocer, and instead views food as an additive purchase for shoppers.

While that may be true, it means Target will need to find other ways of bringing shoppers into its stores. In the meantime, Target has increased the frequency of shipments in fresh produce and will roll out some of the changes it's been testing in LA and Dallas.

Grocery accounts for roughly one-fifth of Target's annual revenue.

"Food will always be challenged at Target, at least for the foreseeable future," O'Shea said.

Analysts were also cautious about Target's decision to challenge Wal-Mart on price, noting that Wal-Mart's scale and vendor relationships will make it a tough battle. Meanwhile, they'll need to increase the speed with which they sell products to help make up for the differential.

On the plus side, O'Shea said that lowering prices on food and other household essentials should help Target drive traffic to its stores, while still allowing it to charge a premium for its exclusive apparel and home goods products.

"Reverting to everyday low prices will get them off this promotional merry-go-round that they've been on," he said.

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