Target Results Disappoint; Cuts Profit Outlook For The Year

Target (NYSE:TGT) recently reported disappointing Q3 results as its sales growth was weighed down by the weak retail environment in the U.S. The company’s comparable store sales increased by just 0.9% while the market was expecting it to be around 1.3%. Moreover, Target’s net income stumbled by almost 50% due to weak sales growth and high pre-opening expenses related to its Canadian expansion. Following the earnings release, the retailer cut its profit outlook for the year as it expects highly promotional and competitive holiday season. ^[1] Despite Target’s efforts to drive store traffic, customers were reluctant to visit its stores during the quarter. The retailer continued to struggle in Canada due to its inventory management issues, and we do not expect it to bounce back any time soon.

Our price estimate for Target stands at $76, implying a premium of near 15% to the market price. However, We’re in the process of updating our price estimate in light of the recent earnings.

See our complete analysis for Target

Target’s Growth Remained Slow Despite Its Efforts

Target mainly relies on its exclusive product offerings and rewards program to drive store traffic. During the quarter, the retailer continued to introduce such products to attract its customers. It launched a new line of men’s pants in partnership with a premium brand Hagger and expanded its hair assortment with exclusive launch of Toni & Guy Hair Meet Wardrobe. Additionally, Target continued its exclusive partnerships with influential artist Justin Timberlake to release a special edition of the continuation of his third studio album, the “20/20 Experience” featuring two exclusive bonus tracks.

Target’s 5% REDcard rewards program has been extremely successful so far. The company has stated that its REDcard customers tend to visit twice as often as its regular customers and spend about 50% more. REDcard penetration increased by about 3% in fiscal 2012, and has nearly tripled in the last two years. Even during the weak second quarter of fiscal 2013, penetration of sales on Target’s proprietary debit and credit cards increased by almost 600 basis points driven by increasing adoption of REDcard rewards program.

Despite these efforts, the number of transactions at Target stores declined by almost 1.3% due to the prevailing economic weakness in the U.S. According to Target’s executive vice president of merchandising, some Target customers were reluctant to visit the stores due to the fear that they might be tempted to buy more. ^[1] This year, U.S. buyers’ discretionary spending has been hit by slow job growth, increased taxes, higher healthcare costs, gasoline price inflation and a change in spending patterns. However, there was a positive sign for the company in the form of increased value per transaction. People have been spending more on long lasting products such as cars, furniture and electronics to take advantage of low interest rates. Target benefited from this trend to a small extent. ^[1]

The Retailer Is In For A Rough Holiday Season

Target lowered its profit outlook for the entire year as it expects the holiday season to be highly competitive. Its rival Wal-Mart (WMT) has promised to offer aggressive discounts earlier than usual in order to a grab a huge share of the holiday spending. The season itself is not looking too promising as it is expected to see its weakest gains since 2009. According to ShopperTrak, retail sales in November and December are likely to rise by just 2.4% while they improved by 3% last year and 4% in 2011 and 2010. Moreover, store traffic is expected to fall by almost 1.4%. ^[2] According to a poll conducted by Reuters, about 33% of consumers are planning to spend less on electronics, toys and jewelry, and 27% are planning to lower their spending on apparel this holiday season. ^[3] Additionally, this year’s holiday season is shorter than the season last year, which provides a smaller window to capture holiday spending. Anticipating this, Target reduced its holiday hiring a couple of months back. Since the retailer wasn’t expecting much in terms of sales growth, it was looking to shield its bottom-line growth. ^[4] Therefore, we believe that the company will have a tough time during the holiday season 2013.

Cold Start In Canada Is Not Looking Good

Target started its operations in Canada earlier this year and has struggled to meet its sales projections so far. During the third quarter of fiscal 2013, the retailer generated about $333 million in revenues and reported an operating loss of $238 million due to low gross margins (14.8%) and high start-up costs. Target had to usher heavy discounts to clear off its inventory as it was unable to drive sufficient store traffic, which affected its gross margins. ^[5] While the impact of start-up costs will subside in the future, improper inventory management will remain a worry for the company.

According to Kantar Research, there was a significant difference in what the customers needed and what was available in stores. ^[5] A survey conducted by Forum Research suggested that only 27% of the customers polled were “very satisfied” with their experience at Target. Others felt that the products were too expensive and that the retailer was not able to meet customer demand since a lot of products were out of stock. ^[6] Although Target is trying to catch up with its inventory needs, long lead times are not helping. ^[5] It is quite clear that the company needs to establish a stable and a responsive supply chain in order to generate better sales in the future. However, it won’t be easy as the retail landscape in Canada is highly developed and competitive.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Target Shoppers Put Less In Their Carts, The Wall Street Journal, Nov 21 2013 [↩] [↩] [↩]
2. ShopperTrak Expects Holiday Sales Will Increase in 2013, ShopperTrak, Sept 17 2013 [↩]
3. U.S. holiday sales expected to rise less than last year: ShopperTrak, Reuters, Sept 17 2013 [↩]
4. Target to reduce 2013 holiday hiring, CNN Money, Sept 20 2013 [↩]
5. Canada troubles hurt Target on eve of price-war season, StarTribune, Nov 21 2013 [↩] [↩] [↩]
6. Target profits dragged down by Canadian expansion, wary shoppers, CBC News, Aug 21 2013 [↩]