Bleak Holiday Season, Data Breach And Canadian Losses Dampen Target’s Q4 Results, But Outlook Is Better

One of the biggest retailers in the U.S. Target (NYSE:TGT) recently reported its Q4 and fiscal 2013 results. The company recorded a decline of 2.5% in its comparable store sales on account of weak holiday sales and the nation-wide data breach. Due to the impact of low consumer confidence, theft of personal information and extreme weather conditions, transactions at Target stores plummeted by 5.5%. Additionally, the retailer’s profits stumbled by more than 40% primarily due to huge operating losses in Canada.

Despite the disappointing results, we believe that Target can regain its growth momentum in the long run. The company’s store traffic should recover gradually as data breach impact fades. The contribution of Target’s direct channel is likely to improve in the future driven by its robust growth and the retailer’s investments on this front. The company’s smaller stores (CityTarget) continue to perform well, which has encouraged it to develop another such format Target Express. Given that Wal-Mart‘s (NYSE:WMT) small stores have been extremely successful, the future for Target’s small stores looks promising. In Canada, the retailer expects to double its revenues this year with its gross margins at a meaningful level.

Our price estimate for Target stands at $74, implying a premium of around 20% to the market price. However, we’re in the process of updating our model in light of the recent earnings release. See our complete analysis for Target

Impact Of The Data Breach Will Fade

Half way through the month of December, Target revealed the massive data breach in the U.S., in which personal information including credit/debit card details of close to 110 million individuals was stolen. Last month, the company stated that while its sales were going better-than-expected before the breach, they were meaningfully weaker after disclosure of the breach. ^[1] We believe that customers bought less at Target as they felt that their credit card/debit card security had been compromised.

However, we do not expect the data breach to have any long term impact on the company. Consumers did not lose much interest in the retailer as polls conducted in Minnesota after the breach found that only 5% of consumers decided to stop shopping at Target. ^[2] To rebuild the confidence of those shoppers, the company ensured zero liabilities of any fraudulent charges. It also increased fraud detection of REDcard holders and provided them with credit monitoring and identity theft protection. Target is working with third-party experts to plug the loopholes that caused this breach. The retailer is even investing more than $100 million to equip its stores with advanced chip-enabled technology for additional security. Target is also issuing its own brand smart chip credit and debit cards. ^[3] Moreover, financial institutions have already replaced about 85% of cards affected by the data breach at Target free of cost. ^[4] Therefore, we believe that the impact of the data breach will gradually subside.

Focus On Improving Online Sales

Although Target’s e-commerce business does not contribute much to its overall revenues, the channel is quite strong. During the last year’s holiday season, the retailer registered healthy revenue growth in its digital channel. Through most of last year, Target’s digital traffic and sales remained ahead of the industry averages. Interestingly, the retailer’s mobile app was the most browsed app on smartphones and tablets in 2013. Mobile Commerce Daily even named Target Mobile Retailer and Commerce Website of the year. Since the digital channel currently accounts for an immaterial portion of Target’s sales, the cheap chic retailer is working hard to make it a bigger business. ^[3]

The company’s mobile saving tool Cartwheel, launched in partnership with Facebook last year, has found tremendous acceptance among customers. Since its inception, more than 5 million users have signed up and saved over $43 million. Encouraged by this, Target is planning to make further enhancements in Cartwheel. It recently added a bar code scanning feature that will identify if there is a Cartwheel deal on a particular product. Additionally, the retailer is increasing its investments in flexible fulfilling in order to improve the customer service. In November 2013, Target launched in-store pick up service (order online and pick at stores) throughout its store fleet. Within a quarter, this service accounted for about 10% of the total online orders. Interestingly, close to 30% of the customers who visited stores to pick up their online orders ended up buying more. This implies that customers’ online shopping interest is helping Target enhance its store sales.

Target Takes Another Step Towards The Smaller Format Race

Target introduced its smaller format concept CityTarget for urban markets about a couple of years ago. These stores have performed very well so far and they delivered high-single digit comparable store sales growth throughout their second year of operation. In response, the company is developing a separate small format known as Target Express, which is about 15% the size of a general merchandise store. Target is planning to offer private label daily need products such as food, healthcare, beauty and other household essentials in these stores. ^[3] This strategy appears to be inspired by the tremendous success Wal-Mart’s smaller stores have seen in the U.S. Target will pilot its first Target Express stores in July this year, and will plan the format’s expansion based on its performance. However, Target Express will face stiff competition from Wal-Mart Express and Dollar chains.

Target Expects Canadian Operations To Pick Up In 2014

Target’s start in Canada has been bumpy mainly due to low customer satisfaction, poor inventory management and high preopening expenses. Canadian buyers haven’t been complete satisfied with their shopping experience at Target as they felt that many products were out of stock. In Q4, the segment’s gross margins plummeted to 4.4% as the company ushered heavy markdowns to clear the excess unsold inventory. Overall, the Canadian segment generated $1.3 billion in revenues and clocked up $941 million losses in 2013.

However, the company expects 2014 to be different. Aggressive markdowns during the fourth quarter have helped the retailer attain a clean inventory position and it expects to double its Canadian revenues this year. Also, Target stated that the gross margins rates will be around 30% in 2014. Although the company is optimistic about its Canadian business, it still remains to be seen if the current year will be any different.

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1. Target Provides Update On Data Breach and Financial Performance, Target, Jan 10 2014 [↩]
2. Target Shoppers Shrug Off Massive Credit Card Data Breach, Time, Feb 20 2014 [↩]
3. Target’s Q4 fiscal 2013 earnings transcript, Feb 26 2014 [↩] [↩] [↩]
4. Cost of Replacing Credit Card After Target Breach Estimated at $200 million, The Wall Street Journal, Feb 18 2014 [↩]