Target Earnings Preview: Soft Back-To-School Season Can Hamper Growth

Target (NYSE:TGT), one of the biggest retailers in the U.S., has been struggling for growth over the past few quarters due to prevailing economic weakness in the U.S. Since the start of the year, the U.S. retail market growth had been sluggish, a condition that continued in the recently concluded back-to-school season. Therefore we believe Target’s upcoming Q3 fiscal 2013 earnings results on Q3 fiscal 2013 will reflect slow growth on account of soft back-to-school season sales. However, Target’s rewards program has played a crucial role in driving store traffic over the past and it should help offset the industry weakness in this quarter as well. Also, the companies strong merchandise offering might help the retailer keep customers interested amid an edgy retail environment. In its international business, Target’s Canadian operations have had a choppy start and their near-term outlook is not very bright. [Read:Target’s Rough Ride In Canada Will Persist In The Near Term] It will be interesting to see if some positives come out for Target Canada in this quarter.

Our price estimate for Target stands at $76, implying a premium of near 15% to the market price. We’ll update our price estimate post earnings.

See our complete analysis for Target

Retail Market Remained Weak During The Quarter

This year, U.S. buyers have been extremely cautious about their spending due to an uncertain economic environment. Factors such as the 2% payroll tax hike at the start of the year, high unemployment, gasoline price increases and higher healthcare costs have all impacted consumer confidence. Moreover, with still low interest rates, consumers have been spending more on houses, cars and other long lasting products.  Consumers have focused on these Durable Goods, as well as electronics and furniture, while holding back on smaller consumable products. Even essential items such as groceries have been hit, which is evident from Wal-Mart‘s (NYSE:WMT) results during the previous two quarters. Due to these factors, the U.S. retail market growth has been weak.

U.S. retail sales, excluding the automotive sector, increased by just 0.1% in August, which was significantly lower than the expected 0.4% growth. ^[1] Moreover, the retail market growth remained modest in September on account of low consumer confidence arising from slow job growth and the budget fight in Washington. In October, 16 day government shutdown slowed job growth and weighed on consumer confidence. This impacted the retail market growth during the month. Even Target’s comparable store sales growth during the second quarter remained well below the market’s expectations. The retailer also issued an updated guidance at the end of Q2 reducing its comparable store sales growth forecast from 2%-3% to 1% for the entire fiscal year. Therefore, we believe that Q3 won’t be the best quarter for Target.

Additionally, warmer than usual temperature in October is likely to weigh on Target’s apparel sales, which accounts for about 20% of its revenues. Towards the beginning of the month, The Weather Channel had stated that the month will be relatively warm, which will hurt the U.S. apparel market. ^[2]

Reward Programs: REDcard & Pharmacy Might Help In Driving Store Traffic

Since its launch approximately two years ago, Target’s 5% REDcard loyalty program has been notable in driving store traffic. The loyalty program allows customers to save money when they shop at Target stores using its brand credit card. The company has stated that its REDcard customers tend to visit twice as often as its regular customers and spend about 50% more. REDcard penetration increased by about 3% in fiscal 2012, and has nearly tripled in the last two years. ^[3] During the second quarter of fiscal 2013, penetration of sales on Target’s proprietary debit and credit cards increased by almost 600 basis points driven by increasing adoption of REDcard rewards program. ^[4]

Target’s second, relatively new loyalty program, Pharmacy Rewards, has also been successful. Pharmacy guests have shopped at Target stores about three times more often, and spent 50% more than, non-pharmacy guests. In this program, customers get 5% off on shopping after filling five eligible prescriptions. ^[5] Due to their attractive benefits, we expect these rewards programs to play some role in driving store traffic.

Strong Product Offerings Can Continue To Work In Target’s Favor

Target is known for being innovative with its merchandise as it offers exclusive and limited edition products in partnership with various designers and other popular personalities. The retailer has launched a number of successful collections over the past in partnerships with designers such as Prabal Gurung, Kate Young, Lauren Bush Lauren, and companies such as Warner Bros. and DC Entertainment. ^[6]

During the third quarter, Target introduced a new line of men’s pants in partnership with a premium brand Hagger. The retailer also expanded its hair assortment with exclusive launch of Toni & Guy Hair Meet Wardrobe, a premium hair care line introduced in the U.K. in 2011. Target continued its exclusive partnerships with influential artist Justin Timberlake to release a special edition of the continuation of his third studio album, the “20/20 Experience” featuring two exclusive bonus tracks. ^[4] We believe that such offerings play an important role in bringing customers to Target stores, who end up buying more given the retailer’s diverse product range. All in all, the company is executing well in a relatively tough environment.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Retail sales fall short in August, temper fed speculation, CNBC, Sept 13 2013 [↩]
2. Warm october could hinder fall retail sales, Yahoo Finance, Oct 8 2013 [↩]
3. Target’s Q4 fiscal 2012 earnings transcript, Feb 27 2013 [↩]
4. Target’s Q2 fiscal 2013 earnings transcript, Aug 21 2013 [↩] [↩]
5. Pharmacy Rewards [↩]
6. Target’s Q1 fiscal 2013 earnings transcript, May 22 2013 [↩]