Target’s Earnings Surprise As Sales And Profits Rise

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The impact of last year’s data breach at Target (NYSE:TGT) appears to have faded. After six consecutive quarters of flat or negative comparable sales growth, the retailer finally reported 1.2% rise in this metric in Q3 fiscal 2014, comprehensively beating the street estimate of 0.6% rise. [1] The growth was even better than Target’s own guidance of 0%-1% growth. The retailer’s sales benefited from an improvement in consumer sentiment driven by a fall in jobless rate and fuel prices. Also, we believe that Target’s efforts to ensure its customers’ credit safety had a marginal positive impact on its store traffic, that ultimately helped its sales. The company said in its earnings call that it has moderated the level of promotional activities, that were deliberately driven higher after the data breach. [2] Hence, it is safe to say that customers are gradually regaining their confidence in the company. Encouraged by its improving performance and a promising forecast for the holiday season, Target expects 2% growth in its comparable sales during the holiday quarter. [2]

Although gross margins shrunk by 50 basis points as compared to last year, Target’s profits increased 3.1% to $352 million in Q3, as it paid less in breach related expenses. In contrast, the retailer had paid $111 million in breach related expenses in Q2 fiscal 2014, which had dragged its earnings down by 60%. In the third quarter, Target reported earnings per share of $0.55, that was some way ahead of the consensus estimate of $0.47. [1] Following these results, Target’s shares increased by more than 5%.

Our price estimate for Target stands at $67.53, implying a discount of about 5% to the current market price. However, we are in the process of updating our model in light of the recent earnings release.

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The company’s Canadian business, which struggled throughout last year on account of poor customer response and high pre-opening expenses, showed small signs of recovery. The segment’s revenues increased by 43.8% to $479 million, and gross margins improved to 19.5% from 14.8% in the same quarter last year. Although most of Target Canada’s revenue growth can be attributed to an increase in the number of stores, the retailer’s comparable sales helped as well for the first time. In Q2 fiscal 2014, Target Canada’s comparable sales had declined by 11.4%, but they grew by 1.9% in the recently concluded quarter. [3] Target’s Canada CEO had stated in an interview last month that traffic trends in the third quarter were better as compared to the second quarter, which indicates that the company’s efforts to augment its inventory management system have started to yield positive results.

Even though the Canadian segment still remains a loss making business, its losses have decreased by 11% as compared to the same quarter last year. Target expects its results to improve in the near future, backed by its ongoing efforts to stock shelves with affordable and relevant products. One of the main reasons why the retailer struggled in Canada was the fact that its merchandise wasn’t inline with the consumer demand. During the recent earnings release, Target CEO, Brian Cornell, said that the company has made significant improvements in Canada on facets such as operations, pricing and assortments in time for Holiday season, and he expects the outcome to be good.

However, the most promising aspect of Target’s results was the 30% rise in its online sales. The company saw a surge in online orders during the quarter owing to the industry-wide shift from store to web shopping, and the retailer’s own omni-channel efforts. Target expects this growth to accelerate in the fourth quarter as online spending during the holiday season is expected to rise by 16%, and the cheap chic retailer has announced free shipping on all holiday season purchases. [4] The company said that it has witnessed a significant rise in web orders since its free shipping announcement. [5] Even beyond the holiday season, the future for Target’s e-commerce business looks good, as the retailer is aggressively employing strategies to enhance its web product portfolio and omni-channel presence.

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Notes:
  1. Target U.S. sales beat expectations, loss-making Canada unit faces review, Reuters, Nov 19 2014 [] []
  2. Target’s Q3 fiscal 2014 earnings transcript, Nov 19 2014 [] []
  3. Target Reports Third Quarter 2014 Earnings, Target, Nov 19 2014 []
  4. comScore Forecasts 16 Percent Growth to $61 Billion in 2014 U.S. Holiday E-Commerce Spending on Desktop and Mobile, Comscore, Nov 18 2014 []
  5. Target delivers and upbeat earnings surprise just before the holiday season, The Washington Post, Nov 19 2014 []