Data Breach Repercussions And Falling Traffic To Subdue Target’s Results

‘Cheap chick’ retailer Target (NYSE:TGT) is scheduled to release its Q2 fiscal 2014 earnings on August 20. In a recent press release, the company slashed its second quarter earnings per share guidance from $0.85-$1.00 to $0.78, citing the data breach and debt retirement expenses as primary reasons. Target incurred gross expenses of $148 million in actual and potential breach-related claims partially offset by $38 million in insurance receivables. The retailer also incurred $285 million in pre-tax losses related to debt retirement costs. ^[1]

In addition to suppressing Target’s earnings, the December 2013 data breach is impacting customer confidence in the company, which is making it difficult for Target to attract customers. This is a big concern for the company given that industry-wide foot traffic is already declining due to gradual customer shift to online channel, where Target’s presence is almost negligible. In its recent update, the company guided its Q2 comparable store sales to remain flat with weaker-than-expected EBITDA (earnings before interest tax depreciation and amortization) margins, on account of traffic driving promotional activities.

Recently, Target Canada CEO, Mark Schindele, outlined certain turnaround efforts of the company’s botched up Canadian expansion. He is mainly looking to augment the retailer’s supply chain and expects to see some measurable results by this fall. ^[2] However, for the second quarter, Target expects its results to remain weak due to its inventory problems.

Our price estimate for Target stands at $67.53, implying a premium of less than 15% to the market price.

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The Effect of Data Breach Still Lingers

In mid December, Target suffered one of the biggest data breaches in the U.S. history, in which personal information of over 70 million customers was stolen. This had a big impact on the retailer’s sales as buyers avoided the company in the wake of compromised credit/debit card security. Although Target’s response to this situation was prompt, the results weren’t too effective. The company ensured zero liability for fraudulent charges and improved fraud detection, but buyers remained concerned about shopping at Target. According to Emily Collins of Forrester Research, consumers are always concerned when it comes to sharing data. ^[3] They are worried about phishing scams and theft of identity, and hence, rebuilding their faith after such an event will take some time. Meanwhile, Target’s comparable sales will continue to falter.

The company is investing a significant amount in installing new technologies for added security. It increased fraud detection for REDcard holders and provided them with credit monitoring and identity theft protection. Target started equipping  its stores with advanced chip-enabled technology to enhance the level of security. Following the theft, Target hired Verizon Enterprise Solutions to investigate and plug loopholes that caused this breach. Apart from breach-related claims, expenses related to these initiatives will hurt the company’s profits.

Falling Foot Traffic will Add to Target’s Problems

Due to the increased proliferation of smartphones and tablets, and the convenience of online shopping, U.S. buyers have been making more purchases online. Subsequently, they are visiting fewer stores, which is a concern for a number of retailers who do not have a sizable online presence. As per the data compiled by ShopperTrak, a firm that tracks store traffic in over 40,000 outlets across the U.S., store visits have fallen consistently by close to 5% year over year in all the months of the past two years, barring April 2014. This is impacting sales of retailers such as Wal-Mart (NYSE:WMT) and Target, who rely on store sales for a bulk of their revenues. ^[4]

Although gradual online shift is resulting in sturdy growth in online retail sales, it isn’t helping Target much since it earns close to 98% of its revenues from store sales. Even if the retailer’s online revenues had increased considerably during the quarter, which is unlikely given the low customer confidence in Target’s payment system, a fall in foot traffic would have easily negated its impact. During the quarter, the retailer ushered heavy markdowns to compensate for low store traffic, which suppressed its sales growth and margins.

Canadian Supply Chain to Improve

With high hopes, Target entered Canada in 2013 and established a massive 124 store network during the year. However, the company’s decision to expand aggressively without setting up a sturdy supply chain first, wasn’t the best one. Shoppers weren’t satisfied with their experience at Target due to high prices, out of stock products, and a poor selection of merchandise. The company clocked up close to $1 billion in losses on account of high pre-opening expenses, weak demand and heavy discounting to clear surplus inventory.

Recently, Target Canada’s CEO, Mark Schindele, highlighted three key areas where the company needs to focus for an effective turnaround:  supply chain, pricing and merchandise selection. As Target hastily entered Canada, it did not set up its supply chain system effectively. While traditionally minimum order quantities are aggregated at the vendor end, Target initially did this at its distribution centers, which made tracking purchase orders difficult. As a result, there was a huge difference between the shipments received at warehouses and inventory featuring in Target’s computer system. The company will look to rectify this shortcoming by re-training its staff on the software since they are accustomed to pushing inventory manually through the system, which led to inconsistency in the inventory monitoring. Also, with a year’s experience in Canadian retail, the company would now be in a better position to forecast demand, which should help it improve inventory management.

In addition, the cheap chic retailer has launched its price match strategy in Canada, where buyers can match merchandise prices at Target with Amazon.ca and Walmart.ca. The retailer has also launched 30,000 new products for the market and has partnered with famous interior decorator, Sarah Richardson, to expand the line of its exclusive collections. The company expects these strategies to have some positive impact in the near future, but second quarter results will remain under pressure.

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1. Target Provides Preliminary Update on Second-Quarter Expenses Related to the Data Breach and Debt Retirement, Target, Aug 5 2014 [↩]
2. Target says supply chain “reset” will help it fix Canada woes, Reuters, Aug 12 2013 [↩]
3. Loyalty programs could feel Target data breach fallout, CNBC, Jan 14 2014 [↩]
4. Gap, L Brands Drive July Retail Sales, The Wall Street Journal, Aug 7 2014 [↩]