Coverage Launch: $65 Trefis Price Estimate for Target

Target (NYSE:TGT) is one of top ten largest retailers in the U.S. by sales and competes with companies like Wal-Mart (NYSE:WMT), Costco (NASDAQ:COST), Amazon (NASDAQ:AMZN) and Best Buy (NYSE:BBY). The retailer sells a wide variety of merchandise from household essentials and apparel to electronics and food and has carved out a niche for itself as a “cheap chic” retailer.

We recently launched coverage of Target with a $64.60 price estimate for the company’s stock. We have broken down our analysis of Target into three main business segments:

1. Target – US

2. Target – International

3. Credit Card

U.S. Retail Market

The U.S. retail market has made a strong recovery and sales and operating margins are approaching peak levels of the pre-recessionary period. As the health of the U.S. economy improves, consumer spending will increase from 2010 levels because of various factors like improving employment, which will lift wages and boost confidence in the future. This in addition to the positive wealth effect from the stock market’s recovery will also help spending trends.

For large retailers like Wal-Mart and Target, long-term sales and income growth depends largely on the company’s ability to open new stores and expand into new markets. Although consumer spending is increasing, new store openings run the risk of cannibalizing sales from existing stores.

However, crude oil prices are also on the rise as prices have passed the $90/barrel mark on macro and political concerns. Import prices jumped by 1.5% in January 2011 on the back of higher prices for oil and other commodities. The increase in gas prices could suppress consumer spending while higher commodity prices can hurt companies’ gross margin by increasing its costs.

Target’s International Expansion

In its first expansion outside the U.S., Target bought leases for 220 Zellers stores, one of Canada’s largest mass merchandise retailers for $1.8 billion. Target plans to take its international stores count to 100 to 150 by 2013 and 2014 and the remaining stores will be taken up by Target or converted to other brands.

As retail giants such as Wal-Mart increasingly saturate the U.S. market, companies are beginning to establish a presence overseas in order to seize market share in other countries. Wal-Mart, for example, has over 4,000 stores in Central and South America, Mexico, Canada, Japan, China, and the United Kingdom. International sales contributed 25% to Wal-Mart’s 2009 sales.

With these plans for international expansion, Target is now positioned to compete with Wal-Mart and other major retailers that operate globally. Target has also considered opening stores in Mexico and Latin America in the next 3-5 years.

Merchandising Initiatives Taken in U.S. Will Boost Sales

Target plans to introduce ‘PFresh’ in-store food and grocery sections in approximately 850 discount stores by end of 2011. The company expects ‘P-fresh’ to boost 2011 comparable store sales by 1% to 2%. Target also plans to imitate plans laid out by its bigger peer Wal-Mart that plans to introduce a smaller store format of 60K to 100K square feet compared with its typical format of 125K to 180K square feet in an effort to tap urban markets. The first store is expected to debut in 2012 in Seattle.

Target used to focus on the suitability of its large store format for a particular location, which reduces access to country’s densely populated urban regions and space-crunched cities. This approach will help the company increase its sales (measured in terms of revenue per square feet).

Target has also increased its presence with mobile applications. It has recently rolled out a new program that sends coupon right to customers’ cell phones. Mobile coupons will reduce the hassle for consumers and help Target increase its store sales. It has also launched a bar code scanner for iPhone and Android devices that help scan product barcodes with the built-in camera to view item details, read reviews or add to a list. We believe initiatives like this will also help drive sales.

See our full analysis of Target.