Target’s Growth Can Continue Despite A Disappointing Quarter

by Trefis Team
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Target
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Quick Take

  • Target’s comparable store sales declined slightly in Q1 due to the unusually long winter and the payroll tax increase.
  • Target lowered its full year guidance; the inventory hangover due to weak sales will hamper its Q2 results.
  • However, we remain positive on Target’s long-term outlook supported by its REDcard and pharmacy rewards programs, strong product offerings, Canadian expansion, CityTarget stores and growing e-commerce business.

Similar to Wal-Mart (NYSE:WMT), Target‘s (NYSE:TGT) Q1 fiscal 2013 results were disappointing. The retailer’s comparable store sales (CSS) declined due to the unusually long winter and the payroll tax increase. While the prolonged cold impacted the sales of seasonal products, the tax increase weighed on overall consumer spending. The results were weak enough to force Target to lower its annual guidance. However, we remain optimistic on the company’s long-term outlook due to its firm focus on digital channel, strong product offerings, Canadian expansion and CityTarget stores. Also, Target’s REDcard and pharmacy rewards programs are likely to remain powerful sales drivers in the future as well.

See our complete analysis for Target

Recap Of The First Quarter

The winter season in the U.S. was unusually long this year, which impacted the demand for products that suit warmer climate. Furthermore, due to the sluggish economy, the payroll tax increase and delayed tax refunds, U.S. buyers remained cautious about their spending. This troubled a number of retailers including Target. The company reported a decline of 0.6 % in comparable store sales with 1.9% fewer transactions. [1] The CSS of weather sensitive products such as spring clothing, fans, lawn, patio and sporting goods was about 6-7 percentage points lower than other product assortments. [1] This gap was even wider in regions with below-average temperatures. The impact of cold weather was most prominent in March as it was the coldest in the last 17 years. [2] As its effect faded, Target saw a substantial improvement in April sales. However, it was not strong enough to lift the retailer’s Q1 results.

Why We Remain Optimistic On Target’s Long Term Outlook?

Apart from Target’s valuable REDcard & Pharmacy Rewards programs, we believe that the following factors can drive growth in the future.

Focus On Digital Channel:

Despite the impact of cold weather and the payroll tax increase, online traffic and sales have grown at a healthy pace. During the quarter, Target’s e-commerce sales increased by 15% and surprisingly, sales grew by 20% in weather-sensitive categories. [1] The mobile channel, which accounts for 30% of Target’s direct-to-consumer revenues, registered triple digit growth in both sales and traffic. [1] Following the footsteps of Amazon (NASDAQ:AMZN) and Wal-Mart, Target also started testing same-day delivery in collaboration with Google (NASDAQ:GOOG) and eBay (NASDAQ:EBAY). [3] If this generates positive results, it can be a revelation for Target’s direct-to-consumer channel.

Recently, the company launched a new website called “Cartwheel” in partnership with Facebook which allows users to log in and gain access to various discounts, which can be redeemed at stores. [4] Target stated that thousands of guests signed up on the website during the first week and already 10% of them have redeemed some offers. [1] These numbers aren’t significant yet, but could rise substantially going forward given the general consumer shift to Internet. In March, the company also announced an agreement to acquire two e-commerce businesses – ChEFS Catalog and Cooking.com – to grow its presence in cooking and kitchenware market. [5] The retailer plans to combine these two to create a wholly owned subsidiary of Target. Additionally, it is looking to launch a program that will allow customers to place orders online and pick them up at stores. [1] Wal-Mart already provides such service for its customers and it has been successful so far. We believe that along with the anticipated growth of the online retail market in the U.S., these efforts will help Target improve its comparable store sales.

Canadian Expansion:

During the first quarter, Target opened 24 stores in Canada, which have garnered significant customer attention. [1] These stores generated about $86 million in revenues driven by a strong performance from home and apparel products. [1] Apart from these, Target is also focusing on food and health & beauty as these categories are likely to play a vital role in increasing the frequency of customer visits. Interestingly, the initial REDcard penetration in the region (2%) came in ahead of Target’s expectations. [1] Since the end of Q1, the retailer has opened 24 more stores in the region and is on track with its plans to end 2013 with 124 stores. Over the course of the next few years, the expansion in Canada will help Target reduce its dependence on the sluggish U.S. economy.

Strong Product Offerings:

Target is known for being innovative with its merchandise as it offers exclusive and limited edition products in partnership with various designers and other popular personalities. Following its successful partnerships with Prabal Gurung and Kate Young, Target recently announced collaboration with designer Lauren Bush Lauren and launch of Feed USA + Target collection. [1] Later this summer, the company will roll out a lifestyle collection of stylish products in sporting goods, stationary, home, apparel and accessories. Recently, Target partnered with Warner Bros. and DC Entertainment to provide Justice League products across various merchandise categories. [1] In the first quarter, it launched a beauty box test to check the customer response to sample beauty products. The results were encouraging as the inventory cleared within a week. [1] This also generated healthy media coverage and the company received promising feedback on social media platforms.

Target utilized a similar strategy for its Canadian stores as well. During the quarter, it partnered with Roots Outfitters, an iconic Canadian brand that offers well crafted and styled line of apparel for men, women and kids. Inspired by the positive customer response, the company will launch an exclusive collection of cabin chic apparel and home products in collaboration with a Roots Canada designer, Beaver Canoe. [1]

Expansion Of CityTarget Stores:

Despite the weak holiday season, prolonged cold weather and the payroll tax increase, small format CityTarget stores have continued to do well. At the end of Q1 fiscal 2013, Target operated six CityTarget stores in four cities and plans to add them throughout the U.S. and Canada over time. [1] These stores are about 40% smaller than a typical SuperTarget store and offer a range of uniquely tailored merchandise that are well-suited for urban dwellers. The company stated that it will maintain a firm focus on the products that attract frequent store visits. Since Target’s presence in the U.S. is nearing a saturation point, CityTarget stores provide a viable expansion path.

Our price estimate for Target stands at $72, implying a premium of 5% to the market price.

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Notes:
  1. Target’s Q1 fiscal 2013 earnings transcript, May 22 2013 [] [] [] [] [] [] [] [] [] [] [] [] [] []
  2. Prolonged Cold Puts Retail Sales In Deep Freeze, CNBC, Mar 31 2013 []
  3. Google Taps Target For Same-Day Delivery Tests, Business Journal, Mar 12 2013 []
  4. introducing Cartwheel: a first-of-its-kind savings program, Target, Mar 8 2013 []
  5. Target to Expand Cooking and Kitchenware Business with Two E-Commerce Acquisitions, Target, Mar 14 2013 []
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