Can Target’s Canadian Operations Recover From The Initial Setback?

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Cheap chic retailer Target (NYSE:TGT) opened its first stores in Canada last year, marking the beginning of its international expansion. While the company had high hopes from the region, poor customer response, lack of a proper supply chain system and high pre-opening expenses weighed heavily on its results in 2013. The retailer opened 124 stores during the year, which generated only $93 in revenue per square feet with gross margins low at 15%. While Canadian consumers were disappointed with Target’s customer service, the recent data breach further diminished their confidence in the company.

Despite its initial fumble and hurt brand image, Target expects its Canadian operations to improve gradually. The retailer is taking several steps to reaffirm customers’ faith in the company. It is looking to aggressively promote its REDcard rewards program and has already achieved a clean inventory position for 2014 that will help it operate with fewer markdowns. That said, the Canadian retail market is not as lucrative as some developing nations, due to a slow economy, an increase in cross-border shopping and a small population. Moreover, the retail landscape in Canada is highly developed, and new retailers find it hard to compete with the existing ones. Therefore, we believe that Target’s recovery in Canada will be slow.

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Sloppy Start For Target In Canada

Target’s start in Canada wasn’t ideal as it generated just $1.3 billion in revenues in 2013 and clocked up $941 million losses mainly due to high pre-opening expenses. Although the initial response was good, the company didn’t do too well in terms of customer satisfaction. According to a survey conducted by Forum Research, 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. [1] The company failed to properly manage its inventory, due to which it faced both inventory shortage and surplus issues. In Q4 2013, Canadian segment’s gross margins plummeted to 4.4% as Target had to usher heavy markdowns to clear the excess unsold inventory.

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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 were stolen. Subsequently, the company stated that while its sales were going better than expected before the breach, they were meaningfully weaker after disclosure of the breach. Customers bought less at Target as they felt that their credit card/debit card security had been compromised. Although the breach did not directly affect Target Canada due to the difference in its payment system, it might have affected Canadian buyers’ sentiment towards the company. [2]

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Recovery Is Expected

Although the start wasn’t satisfactory, Target believes that it can double its revenues this year and generate $6 billion in revenues by the end of the fifth year. [3] [4] Aggressive markdowns during the fourth quarter of 2013 helped the retailer attain a clean inventory position, which will help it sell products at higher average prices and better margins in 2014. In its recent quarterly results, Target stated that its gross margins rates for Canadian segment will be around 30% in 2014, which is at par with its domestic business margins.

For the long run, the company is relying on the strategy that has helped it succeed in the U.S. From time to time, Target introduces certain exclusive and limited edition collections in partnership with various designers and artists, to entice customers and improve cross selling. Last year, Target introduced several brands and collections in Canada that were very popular in the U.S. It also launched exclusive products for Canada stores, such as Roots Outfitters and Kate Young’s collection (a popular stylist in Hollywood). Although such products could not help Target’s results in 2013, they can add significant revenues in the long term.

Target is also aggressively promoting its REDcard rewards program, which allows customers to save money when they shop at Target stores. Its importance is evident from the fact that REDcard customers tend to visit twice as often as regular customers and spend about 50% more. The retailer’s REDcard penetration in Canada went up to 2.9% within its first year of operation. Considering the REDcard penetration trend in the U.S., we expect this figure to continuously improve in Canada as well, which should positively impact Target’s sales in the region.

However, Recovery Will Not Not Be Easy

Since the recession of 2008-2009, the economic recovery in Canada has been slow due to persistent low consumer confidence. Apart from the luxury goods industry and grocery retailers, the Canadian retail market growth has been weak, which is not a good sign for Target. The company sells most of its products at an affordable price range and earns less than 20% of its revenues from groceries. Hence, the positive aspects of Canadian retail market might not complement Target’s growth.

There has been a considerable rise in cross-border shopping lately, as the Canadian government increased duty-free exemptions on goods in June 2012. As a result, some Canadian shoppers are buying products from the U.S. at lower prices, which is negatively impacting Canada’s retail market growth. Since U.S. retailers provide a wider merchandise selection and discounting practices are more profound in the U.S., it serves as a better shopping destination than Canada. Furthermore, as the consumer audience is small and the retail market is highly developed in Canada, growth of new entries comes mainly at the expense of existing retailers’ sales. Hence, Target will face stiff competition from Canadian retailers going forward. Even if the economic scenario in Canada were to improve in the future, the region will see only a moderate growth in its retail market. This can be attributed to a number of factors such as a saturated market and competitive environment. [5] Therefore, it will not be easy for Target to grow its business at a rapid pace in Canada.

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Notes:
  1. Target profits dragged down by Canadian expansion, wary shoppers, CBC News, Aug 21 2013 []
  2. Target Data Breach May Affect Some Canadians, CBC, Jan 20 2014 []
  3. Target’s Q4 fiscal 2013 earnings transcript, Feb 26 2014 []
  4. Target Canada continues to be a drag on earnings, The Star, Aug 21 2013 []
  5. Retailing In Canada, Euromonitor International, Mar 2013 []