Target To Focus On Growth And Salvage Its Canadian Expansion

Target‘s (NYSE:TGT) Q2 fiscal 2014 earnings fell by a staggering 62% as Canadian losses and aggressive discounting weighed heavily on its profits. The company lowered its guidance for the second time this year, citing a traffic decline and promotional activities as the main reasons. It now expects its full year earnings per share to be around $3.10-$3.30, down from its previous guidance of $3.60-$3.90. During the quarter, Target’s comparable sales remained flat as increase in average spending per customer was offset by 1.3% decline in store traffic. The cheap chic retailer ushered heavy markdowns to attract customers, which dragged its margins down to 30.4% from 31.4% a year earlier. Along with its dismal performance in the U.S., the 11.4% comparable sales decline in Canada summed up a lackluster quarter for Target. ^[1]

Store traffic at Target has declined in the past nine consecutive quarters and its comparable sales growth hasn’t been positive in the last six quarters. U.S. buyers are gradually moving to online shopping, where Target’s presence remains weak. The retailer was once known for its high value, stylish and affordable merchandise. But it seems to have lost this essence due to an aggressive push towards fresh foods, which has hurt its brand image. Also, last year’s data breach at Target has made customers wary of shopping at the company’s stores. These issues pushed Target’s CEO Gregg Steinhafel towards an exit earlier this year and it recently appointed PepsiCo (NYSE:PEP) executive Brian Cornell to succeed him.

Mr. Cornell has made it clear that the company’s priorities are to bring customers back and fix its botched up Canadian expansion. The company is looking to gradually expand its small store network, where traffic trends have been much better than traditional big-box stores. It is also trying to make some changes to its store layouts to provide a better environment for the categories it is best known for. Target is augmenting its omni-channel portfolio to elevate web sales as well as drive greater store traffic. In Canada, the retailer is looking to rectify shortcomings with its supply chain, pricing and merchandise selection,  And expects to see some measurable improvements by this fall.

Our price estimate for Target stands at $67.53, implying a premium of more than 10% to the market price. However, we are in the process of updating our model in light of the recent earnings release.

See our complete analysis for Target

Small Stores Expansion and Tweaks to Store Layout

Target introduced its smaller format concept called CityTarget for urban markets a couple of years ago. A CityTarget store is about 40% smaller than a typical SuperTarget store and offers a range of uniquely tailored merchandise according to the needs of urban dwellers. Since these stores offer products catering to a customer’s daily needs, they generate high sales per square feet. CityTarget stores have performed very well so far and they delivered high single-digit comparable store sales growth throughout their second year of operation. In response, the company developed another small format known as TargetExpress, and launched its first outlet recently. Customers thus far have responded well to this format, generating high store traffic at this initial TargetExpress.

Target hasn’t been too aggressive with its small store expansion plans, which is surprising given the large room for growth. Small store space is only going to get more competitive in the future with the merger of Dollar Tree and Family Dollar, and Wal-Mart’s aggressive expansion. If Target intends to have a substantial small store presence in the country, now is the time to begin.

Target made a name for itself in the U.S. market by selling affordable stylish merchandise. However, with its aggressive push towards groceries, the retailer’s focus on its core categories diminished, which had a negative impact on its brand image. The company is trying to regain its “cheap chic” brand image by making certain changes to its store layout to promote apparel, baby and beauty products. In July alone, Target converted 167 stores to an enhanced layout for baby products, bringing the total to 200. At present, 50 of the retailer’s stores have enhanced the presentation of apparel, and it plans to take this count up to 600 over the next couple of months. Target refreshed the display of its beauty products earlier this year as well, and has seen an encouraging response. The retailer will look to add its rejuvenated formats to more stores, which can help it regain its iconic brand image. ^[2]

Online Growth with Omni-Channel Initiatives

Target’s digital sales increased by 30% during the quarter, primarily driven by 50% increase in mobile traffic. Although traffic on conventional websites declined, conversion rates through both the channels continued to improve. To change its brand perception from just a brick-and-mortar retailer to a complete retailer, Target recently launched a new ad campaign focused on the millennial group. The ad features the company’s prominent omni-channel campaigns such as store pickup, cartwheel and subscriptions, which are considered to be the most important solutions to customers. ^[2]

In July, Target launched a proof-of-concept to integrate Target.com with Cartwheel, which made it easier for customers to access cartwheel (a coupon-like app) through all the channels. The retailer’s store pickup services continue to see great response. The company ran some promotions on store pick up in late July and saw sales volumes escalate almost five times. About one-fifth of new shoppers, who came to stores to pick up their orders, engaged in in-store shopping. Target’s omni-channel platform is helping it improve web as well as store traffic, but its impact isn’t visible due to the small size of its e-commerce channel. However, we believe that the company is headed towards the right direction. It just needs to push aggressively towards its goal.

Canada is Under Review

Target’s Canadian team is in the process of reviewing its last year’s performance based on customer feedback to find out what went wrong. So far, the retailer has identified three key areas, where it needs to rectify its shortcomings. Target has to improve its supply chain, which has been at the base of all its problems. The company is looking to do so by employing a better reporting structure to identify its inventory needs effectively. It is retraining its staff to use best methods to push inventory through the system. Target is even exploring the possibilities of developing new methods specially tailored for Canada.

When Target entered Canada, buyers were expecting its prices to be comparable with Target U.S., but they were expensive. Although the company is reviewing its prices, it believes that its products are already competitively priced. However, Target is ready to take necessary actions to quickly adapt to the Canadian pricing dynamics. 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. Based on customer feedback, the company is adding new product lines to its shelves, which buyers could not find last year. Target will add about 30,000 new SKUs between now and the holiday season, which will bring its total to 70,000 SKUs. The company expects these efforts to show some promise in the near future.

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1. Target Reports Second Quarter 2014 Earnings, Target, Aug 20 2014 [↩]
2. Target’s Q2 fiscal 2014 earnings transcript, Aug 20 [↩] [↩]