Target Corporation (NYSE:TGT) released the earnings results from its most recently completed quarter, and they certainly weren’t spectacular. In a report dated May 21, 2014, analysts Charles Grom, Renato Basanta and John Parke say the 2.3% decline in traffic the big box retailer reported was a big negative in the report. They also don’t like the 130 basis point compression in U.S. gross profit margins.

Target

Because of concerns about these two issues they have bumped their price target down to $54 from $56 a share and maintained their Neutral rating on Target Corporation (NYSE:TGT)

Analyzing the downside in Target’s results

Target Corporation (NYSE:TGT) posted adjusted earnings of 70 cents per share for the first quarter, missing the Sterne Agee team’s estimate of 73 cents per share and the consensus estimate of 72 cents per share. Target had guided for earnings of between 60 cents and 75 cents per share for the quarter.

The analysts say the downside in the big box retailer’s earnings results came mostly from gross margins. They said sales and depreciation and amortization added a little more downside but were partially offset by lower selling, general and administrative expenses and a lower tax rate. At EBIT, total earnings per share downside was 5 cents, mostly due to a miss in the U.S. of 5 cents per share. Target Corporation (NYSE:TGT)’s Canadian operations fared better, however, posting a 3 cent per share upside.

Gross margins a big concern for Target

Target Corporation (NYSE:TGT) reported that same store sales in the U.S. fell .3%, which wasn’t that much worse than the Sterne Agee estimate of flat and close to expectations moving into the earnings report. They note that gross margins fell 156 basis points to 29.2%, missing their estimate of 30.6%. The report also indicated that selling, general and administrative expenses fell 60 basis points after adjusting for expenses related to the data breach and card conversion.

Net adjusted EBIT margins fell 115 basis points to 4.9%, again missing the Sterne Agee estimate of 5.2%, resulting in a downside of 5 cents per share.

The good in Target’s report

The Sterne Agee team noted three positive points for consideration, although they were outweighed by five negative points. Under the positive, Target Corporation (NYSE:TGT) controlled its inventories well, as they increased 3.7% year over year. That tightened the gap between sales and inventory to -230 basis points, compared to -1,470 basis points at the end of the previous quarter.

Second, the analysts say the -.3% comparable store sales was actually ahead of Wall Street estimates at -1% and toward the high end of Target Corporation (NYSE:TGT)’s -2% to flat guidance. The analysts also point out that Target’s average ticket size increased 2.1%. Third, they say Target’s Canadian EBIT of -$211 million was ahead of their estimate of -$240 million. They say improvements in selling, general and administrative expenses were the main driver there.

The bad in Target’s report

The Sterne Agee team saw five negative points in Target Corporation (NYSE:TGT)’s earnings report. The big box retailer cut its fiscal 2014 year earnings per share guidance from between $3.85 and $4.15 per share to between $3.60 and $3.90 per share. This was a 6.3% decline at the midpoint of the guidance. However, they also note that it was expected that Target would cut its guidance.

Second and third, they say the 128 basis point decline in U.S. gross profit margins was a big concern, as was the 50 basis point decline in REDcard penetration quarter over quarter. Fourth, they point to the 2.3% decline in customer traffic, which was the sixth quarterly decline in a row. And fifth, while Canadian sales were a bit of a bright spot, they were at $393 million—still a bit weaker than what the Sterne Agee team had been expecting, which was $426 million.