Target Beats On Revenues But Reports Significant Losses Due To Canada

For the second quarter in a row, cheap chic retailer Target (NYSE:TGT) reported positive growth in its U.S. comparable sales. The company said that its Q4 sales in stores open for over a year increased 3.8%, following 1.2% growth registered in Q3 fiscal 2014. Target’s comparable sales growth was much better than analysts’ expectation of 3%. Overall, the retailer posted revenues of $21.75 billion, slightly ahead of the consensus estimate of $21.63 billion and reflecting a year over year improvement of 4.1%. Excluding one time charges, the company’s earnings per share stood at $1.50, which was again better than market expectations of $1.46.

While this earnings beat appeared strong enough to lead to a material increase in Target’s stock price, the rise remained subdued due to two reasons. First, the company reported significant losses for the quarter owning to its exit from Canada. Second, its Q1 fiscal 2015 earnings guidance remained slightly below analysts’ expectations. Target posted net loss of $2.6 billion or $4.14 per share for the fourth quarter of fiscal 2014, while its profit figure stood at $0.82 per share in the comparable period. It guided its Q1 fiscal 2015 earnings per share at $0.95-$1.05, mean of which fell short of Wall Street estimates of $1.04.

Apart from losses related to Canada, Target’s Q4 earnings were mostly positive, indicating that its turnaround efforts are finally yielding some results. However, a deeper analyses indicates that Target had a very favorable comparable prior year period to beat, as foot traffic in Q4 fiscal 2013 was bogged down by extreme weather and the massive data breach. Nevertheless, a part of the retailer’s growth can be attributed to the surge in its online revenues and improvement in consumer spending. Target has struggled for a long time in s pretty tough U.S. retail environment, but its fall appears to have finally bottomed out.

Our price estimate for Target stands at $70, implying a discount of less than 10% to the current market price. We are in the process of updating our model in line with the recent earnings release and the new reporting structure.

See our complete analysis for Target

Breaking Down U.S. Comparable Sales Growth

Target’s 3.8% comparable sales growth in Q4 was not only better than the street estimates, but was also ahead of its earlier guidance. The company stated that improvement in an store traffic, a surge in online sales, along with effective  merchandising and in-store strategies, drove its comparable sales growth, with increase in traffic being the primary factor.

While growth in traffic may look very promising on the outside, it must be noted that a major share of this improvement is attributable to a favorable comparable period. During the holiday season of 2013, there was a lull in foot traffic as extreme temperatures made it difficult for shoppers to get out of their homes. As a result, they completed most of their shopping online, that severely impacted sales of retailers such as Wal-Mart (NYSE:WMT) and Target, which rely on store sales for over 95% of their revenues. Also, Target unveiled the massive data breach in December 2013, after which many buyers, worried about their credit and debit card security, temporarily stopped shopping at the retailer. This further led to a brief lull in store traffic and the company reported 2.5% fall in its U.S. comparable sales for Q4 fiscal 2013. Therefore, traffic rise on account of aforementioned factors does not imply improvement. It merely reflects underperformance during the comparable period.

In addition to the rise in store traffic, robust growth in online revenues was also partially responsible for the rise in comparable sales. Digital channel revenues improved 36% during the quarter, that too on top of a strong rise in Q4 fiscal 2013. CEO Brian Cornell mentioned that growth in web and mobile sales contributed almost 90 basis points to overall comparable sales growth of 3.8%. Interestingly, this contribution was at 60 basis points in the preceding quarter. Unlike the rise in store traffic against a weak comp, this indeed reflects substantial progress. ^[1] However, Target still needs to travel a long way before its direct-to-consumer channel starts making a bigger contribution.

Other factors that contributed to Target’s comparable sales growth included the continued improvement in REDcard penetration, which settled at 21.1% in Q4. Since REDcard shoppers tend to spend more than regular shoppers, increase in penetration reflects increase in overall spending at Target. Additionally, factors such as holiday marketing, promotions and in-store execution had a minor positive impact on comparable sales.

What Canadian Exit Cost The Company

When Target announced that it will be ending its operations north of the border, it projected a total loss of $5.4 billion related to its Canadian operations. For the three months ended January 31, the company reported net loss of $5.1 billion from discontinued operations ($3.6 billion after tax), that dragged it from a net income of $960 million to a net loss of $2.6 billion. For accounting purposes, Target will report its residual losses (if any) in the upcoming quarter. For the full year, the company reported after tax loss of $4.1 billion attributable to its Canadian business and its net loss settled at $1.6 billion.

Where The Focus Shifts After Canada

Since Target no longer has to worry about its botched up Canadian business, it can now focus its efforts and resources towards aspects that have a promising future. The retailer’s priority is to improve its digital sales and develop a formidable omni-channel portfolio. Target believes that it was among the best digital performers in the industry in 2014 and it can carry this momentum to 2015. Secondly, the company plans to formulate specific strategies for different merchandise categories and clearly define roles for teams looking after these categories. Last year, Target began investing its resources in its “known for” affordable fashion merchandise, which means that its signature categories such as style, baby, kids and wellness will get better product display and more visibility, space and variety. Thirdly, Target plans to employ a localized approach to position its products and store experience in-line with local customer tastes, somewhat similar to what Bed Bath & Beyond (NYSE:BBBY) does. The company’s fourth priority is to test new store formats, given that its CityTarget format and the lone Target Express store are performing very well. ^[1]

Target has a clear set of priorities and it just needs to devise relevant strategies to progress on them. It needs both  talent and resources for this and now has more of both since the closure of the Canadian business. Though another international venture for the company seems a little far fetched, it clearly is in a better position now to rejuvenate its domestic business.

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1. Target’s Q4 fiscal 2014 earnings transcript, Feb 25 2015 [↩] [↩]