Why Target’s Revenue Per Square Feet Will Improve Going Forward

Target‘s (NYSE:TGT) revenue per square feet ( a measure of store productivity) declined consistently from $296 in 2007 to $280 in 2009, owing to the economic downturn in the U.S. However, the figure started improving after 2009, as consumer spending improved with the gradual economic recovery. The retailer’s revenue per square feet improved steadily to $303 in 2012, but declined slightly to $298 in 2013, as several U.S. buyers diverted their spending to long lasting products in the wake of low mortgage rates. Going forward, we expect this figure to improve consistently driven by Target’s online growth, its renewed focus on known-for categories and rewards programs that help in stimulating spending. Also, the expansion of smaller stores, that mainly stock products with high selling frequencies, will help the company generate higher revenues from a limited space. In addition, growth in U.S. GDP and inflation will have a positive impact on the retailer’s revenue per square feet. Overall, we expect the Target’s revenue per square feet to increase at a compound annual growth rate of close to 3% for the next six-seven years.

Our price estimate for Target stands at $67, implying a premium of less than 10% to the current market price.

See our complete analysis for Target

Economic Growth and Inflation

Since the recession of 2008-2009, the U.S. economy has shown signs of slow recovery. Although it is not likely to reach pre-recession levels any time soon, a gradual improvement in consumer confidence and lower unemployment should positively impact consumer spending at Target. Inflation is another factor that drives the growth for same sales volume and will aid growth in the retailer’s revenue per square feet. For the next five-six years, the U.S. annual real GDP growth rate and inflation rate are expected to be roughly around 2.5% and 2%, respectively. ^{[1] [2]} This sums up to a nominal GDP growth rate of about 4.5% for the long-term. However for the past few years, Target’s revenue per square feet growth has lagged behind the U.S. nominal GDP growth rate by an average of 2.5 percentage points. Hence, we project the retailer’s revenue per square feet to increase by only around 2% annually on account of the economic growth. Remaining 1% growth can be attributed to the company’s efforts to improve its store productivity.

Growth in Online Sales

Incremental online sales through the existing store network will help Target improve its revenue per square feet going forward. Even though online sales do not contribute much to the retailer’s revenues at present, they have grown at a robust pace for the past several quarters, and can become a formidable driving force in the long term. Over the last couple of years, there has been a notable change in U.S. buyers’ shopping patterns, as they have increasingly preferred online shopping over store shopping. In almost every month during the last two years, store traffic has declined 5% year over year, but online sales have increased by almost 15% year over year in every quarter during the same period. This shift seems to be a permanent one, given that several retailers are trying to revamp their omni-channel platform, to leverage their physical presence to enhance web and store sales. Target is also deploying several strategies to ensure that it makes the most of the ongoing change in the U.S. retail industry.

Following the footsteps of Wal-Mart (NYSE:WMT) and Amazon (NASDAQ:AMZN), Target is testing same-day delivery for its online orders in collaboration with Google and eBay. It is leveraging the power of social media with its “Cartwheel” app in partnership with Facebook, which allows users to log in and gain access to various offers and discounts. Additionally, Target is adding new categories to its online product portfolio with various acquisitions such as CHEFS Catalog, Cooking.com, and DermStore Beauty Group. It is also installing free wifi in all its stores to promote the use of its mobile apps. With these efforts, we believe that e-commerce can become a relatively bigger business for Target in the future, and have a positive impact on its store productivity. With U.S. online retail market expected to grow at a CAGR of 10% for the next five-six years, increasing its e-commerce revenues at a robust pace should not be a big problem for Target. ^[3]

Expansion of Smaller Stores

To continue its expansion in the U.S. urban markets, Target launched its smaller format stores (CityTarget) in July 2012. A CityTarget store is about 40% smaller than a typical SuperTarget store and offers a range of uniquely tailored merchandise according to the needs of urban dwellers. Since these stores offer products catering to a customer’s daily needs, they generate high sales per square feet. In 2013, these stores performed very well despite the prevailing weakness in the U.S. retail industry, which should encourage the company to open more such stores. Moreover, Target is developing a separate small format known as Target Express, encouraged by the success of Wal-Mart express. These stores are about 15% the size of a general merchandise store, and carry private label daily need products such as food, healthcare, beauty and other household essentials. We believe that there is a lot of expansion room for Target’s small stores since Wal-Mart is expanding its small store network aggressively and some dollar stores operate close to 10,000 stores in the U.S. Currently, Target operates less than 10 small stores in the U.S., but we can expect the count to go up in the future, which can have a positive impact on the retailer’s overall revenue per square feet.

Renewed Focus on Known for Categories

Target made a name for itself in the U.S. market by selling affordable stylish merchandise. However, with its aggressive push towards groceries, the retailer’s focus on its core categories diminished. This had a notable impact on its comparable sales, that gradually faltered amid an uncertain retail environment. To win back customers, Target needs to fall back to its historical strategy of stocking shelves with affordable exclusive and limited edition merchandise.

The company’s new CEO Brian Cornell, who joined Target a couple of months back, is looking to do the same. He is planning to bolster certain product categories that are likely to draw customer attention. Mr . Cornell stated that the company will invest more on baby products, including diapers, clothes and gear, along with children’s products including toys and clothes. Categories such as fashion, furniture, organic food and natural cleaning products will also get extra attention. Also, Target is making certain changes to its store layout to promote apparel, baby and beauty products. In July alone, Target converted 167 stores to an enhanced layout for baby products, bringing the total to 200. At the end of Q2, 50 of the retailer’s stores had enhanced the presentation of apparel, and it had planned to take this count up to 600 by the end of September. Also, Target refreshed the display of its beauty products earlier this year, and has seen an encouraging response. Going forward, the retailer will look to add its rejuvenated formats to more stores. With a better product portfolio, Target can expect to see an increase in customer spending, which will ultimately help its revenue per square feet.

How Significant is this Metric for Target?

We currently project Target’s revenue per square feet to increase from $298 in 2013 to $365 over the course of next six-seven years. However, if the figure were to increase to just $330 owing to the sluggish economic recovery, self-cannibalization and persistent weakness in store traffic, there can be more than 10% downside to our price estimate. On the contrary, if the figure soars up $390 driven by successful expansion of small stores, robust growth in online sales and pleasing customer response to core product categories, there can be about 10% upside to our price estimate for the “cheap chic” retailer.

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1. GDP Forecast, IMF [↩]
2. Inflation, IMF [↩]
3. Forrester Research Online Sales Forecast, 2013-2018, Forrester, Mar 21 2014 [↩]