Foot Traffic Decline And Canadian Losses Will Suppress Target’s Results

When “Cheap chic” retailer Target (NYSE:TGT) comes out with its Q3 fiscal 2014 earnings on November 19th, we expect its struggle in the U.S. and Canada to continue. Store traffic at Target has declined in the past nine quarters and its comparable sales growth hasn’t been positive in the last six quarters. We believe that this trend persisted in the recently concluded quarter, as Target remained aggressive on discounts and foot traffic across the industry fell. While retail sales growth across the U.S. was promising for the three month period ending in October, most of it was attributable to rise in e-commerce sales, where Target’s presence remains weak.

In the second quarter of fiscal 2014, the retailer’s earnings fell by a staggering 62% mainly due to soaring Canadian losses. Although Target is trying hard to fix its botched up Canadian expansion, it is recording significant losses quarter after quarter. The company’s operating losses in Canada increased 11% in the first half of the year and its same-store sales fell 11.4% in Q2. Although Target Canada CEO Mark Schindele recently said that store traffic in the third quarter has improved as compared to the second quarter, we don’t expect to see any significant improvement in the company’s Canadian results. ((Target Canada to experiment with overstocking in turnaround effort, The Globe and Mail, Oct 23 2014))

Our price estimate for Target stands at $67, implying a premium of less than 5% to the current market price.

See our complete analysis for Target

Retail Environment was Good, Foot Traffic was Not

After a slump in the first three months of 2014, U.S. retail sales improved in the second quarter primarily driven by pent-up demand. The positive trend continued in August 2014, as retail sales excluding automobile and gasoline sales increased by 0.5% from the previous month and almost 5% year over year. ^[1] Lower gasoline prices and better employment trends drove consumer confidence higher and that ultimately uplifted retail sales. The unemployment rate fell to just 6.1% in August 2014 from 7.2% in the same period last year. ^[2] In September, although retail sales declined at a greater-than-expected rate of 0.3% from August, they were 4.3% above September 2013′s levels. ^[3] Sentiment continued to improve during the month as the unemployment rate fell to 5.9%. October looked even better as U.S buyers opened up their wallets, apparently encouraged by a promising job scenario.  This resulted in 4% year-over-year growth in U.S. retail sales. ^[4] The unemployment rate declined to a five year low of 5.8%, which had a positive impact on consumer sentiment. In fact, the unemployment rate in October 2014 was 1.4 percentage points below what it was in the same month last year. The Thomson Reuters/University of Michigan’s U.S. consumer sentiment index rose to 86.9 in October, which was its highest value in over seven years. ^[5] As a result, U.S. buyers were more generous with their spending during this year’s Halloween shopping, which resulted in strong retail growth during the fourth week of the month.

However, Target is unlikely to have benefited from the growth in retail sales during the quarter. U.S. buyers have been increasingly switching to online shopping due to its convenience and cost benefits. Since most of the retail growth in August-October can be attributed to the surge in online orders, Target’s weakness becomes evident. The retailer still relies on store sales for close to 97% of its revenues and store traffic in Q3 this year was significantly less than its last year’s levels. According to ShoppeTrak, store traffic has declined by 5% in almost all the months during the last two years. ^{[6] [7]} To better understand the intensity of store traffic decline, it is worth noting that about 17% fewer shoppers visited physical stores in September as compared to the same month last year. ^[8] While the company is making several efforts to revamp its omni-channel platform in the wake of the ongoing online shift, there will not be any significant improvement in Target’s same store sales in the near future on account of incremental online sales.

Canada Unlikely to Have Improved

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 during its first year on account of high pre-opening expenses, weak demand and heavy discounting to clear surplus inventory. Although Target is trying hard to address its inventory issues, it will likely be while before it sees any noticeable results. Hence, third quarter results are unlikely to be any different from what they have been in past. Nevertheless, we will keep an eye out for any progress the company may have made in addressing its shortcomings.

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1. U.S. Retail Sales Rose 0.6% in August, The Wall Street Journal, Sept 12 2014 [↩]
2. Labor Force Statistics from the Current Population Survey, Bureau of Labor Statistics [↩]
3. U.S. Census Bureau News, Oct 15 2014 [↩]
4. U.S. Retail Sales Rise in October from September – Redbook, Nasdaq, Nov 4 2014 [↩]
5. U.S. consumer sentiment at highest since July 2007, Reuters, Oct 31 2014 [↩]
6. Shoppers Are Fleeing Physical Stores, The Wall Street Journal, Aug 5 2014 [↩]
7. Back-To-School Slump Raises Concerns About Holiday Season, Bloomberg, Sept 23 2014 [↩]
8. Brick-and-Mortar traffic falls 17% in September, Retail Dive, Oct 10 2014 [↩]