Target Earnings Preview: Better Marcoeconomic Environment In The U.S. Might Help

One of the biggest retailers in the U.S., Target (NYSE:TGT), has been in the news lately for its botched up Canadian expansion, the massive data breach and changes in top level management structure. The retailer will be in focus once again when it releases its Q1 fiscal 2014 results on May 21. Investors and analysts will be eager to see if the marginal recovery in the U.S. consumer confidence will be strong enough to drive Target’s results, after several customers shied away from the retailer due to the data breach. Target had reported a substantial decline in its sales few months back following the disclosure of the data breach in which the credit/debit card information of millions of customers was stolen. However, the company has been trying its best to win back customers, which may be reflected by better results in the first quarter.

In Canada, Target should report substantial revenue growth since it opened its first store in March last year.  It had only 24 stores operational at the end of Q1 fiscal 2013 compared to over 124 stores in Q1 fiscal 2014. However, the retailer’s store productivity will most likely remain below par given that its supply chain is still underdeveloped and Canadian buyers aren’t completely satisfied with its customer service. Many suspect Target Canada will remain a loss making business this year as well. Apart from the company’s sales results, we will keep an eye out for updates on appointment of a new CEO during the earnings call.

Our price estimate for Target stands at $70, implying a premium of over 15% to the market price.See our complete analysis for Target

Improved Consumer Confidence Can Help Target’s U.S. Results

After being weighed down by harsh weather and sluggish consumer spending, retail sales in the U.S. rebounded in the first quarter (February-April) of 2014, with renewed consumer confidence and better employment data. Consumer confidence index in the U.S. reached 100 in the first quarter, propelled by better employment data, and rising equity and home prices. ^[1] Applications for unemployment benefits dropped to their lowest level in more than three months in early March. Labor Department reported a fall of 9,000 in initial claims for unemployment benefits in the first week of March. Average job growth in February and March (195,000) was much better than what it was in the prior two months. In fact, first time jobless benefits applications in early April were at their pre-rescession levels. ^[2]

Retail sales in February improved marginally by 0.7%, followed by 1.1% jump in March, which was their biggest gain in over 18 months. Once the weather became suitable for store shopping, U.S. buyers were less reluctant to spend on furniture, clothing, general merchandise, health and personal care, food and beverage, sporting goods etc, which is good news for Target. Although market growth slowed down in April to 0.1%, overall growth in the first quarter still looks pleasing. ^[3]

Measures To Regain Customer Confidence After The Data Breach Might Accelerate Recovery

After its sales suffered terribly on account of the data breach, Target took several steps to ensure that customer sentiment towards the company does not suffer. It apologized for the theft of information and assured zero liability for fraudulent charges. By mid February, financial institutions had replaced free of cost about 85% of cards affected by the data breach at Target. The company also increased fraud detection of REDcard holders and provided them with credit monitoring and identity theft protection. It started equipping its stores with advanced chip-enabled technology for additional security. Following the theft, Target hired Verizon Enterprise Solutions to investigate and plug the loopholes that caused this breach. We believe that the ongoing investments in technological enhancements and tweaks in the top management structure might help Target mend its customer confidence, that can help its sales growth in the first quarter. However, these technological changes are estimated to cost the retailer more than $100 million, which will put tremendous pressure on it profitability in the near future.

Problems In Canada Likely To Continue

Target had high hopes from Canada as it invested more than $1.8 billion on 220 Zeller stores and spent an additional $10 million on each of them for renovation. However, the company’s start was abysmal as its 124 stores opened last year generated only $93 in revenue per square feet with gross margins low at 15%. Overall, the Canadian segment rendered $1.3 billion in revenues in 2013 and clocked up $941 million losses mainly due to high pre-opening expenses.

Although the initial response was good, the company didn’t do too well in terms of customer satisfaction due to lack of a proper supply chain system. According to a survey conducted by Forum Research, only 27% of the customers polled were “very satisfied” with their experience at Target. Others felt that the products were too expensive and that the retailer was not able to meet customer demand since a lot of products were out of stock. ^[4] The company failed to properly manage its inventory, due to which it faced both inventory shortage and surplus issues.

Although international expansion was a valid move by Target, its approach was questionable. The company was very aggressive in opening stores without a sturdy supply chain to support its needs. The retailer offered expensive products for Canadian consumers who are highly value conscious and very fond of cross border shopping. Even though Target is trying hard to rectify its shortcomings in Canada, a near term turnaround is highly unlikely. According to Tiburon Research Group, Target is expected to incur a loss of $600 million in 2014.

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1. U.S. consumer confidence rebounds to pre-crises levels in first quarter: Nielsen, Reuters, Apr 29 2014 [↩]
2. Bullish U.S. retail sales brighten growth outlook, Reuters, Apr 14 2014 [↩]
3. Retail sales slow, but growth outlook still upbeat, Reuters, May 13 2014 [↩]
4. Target profits dragged down by Canadian expansion, wary shoppers, CBC News, Aug 21 2013 [↩]