Target To Discontinue Its Canadian Business

After persevering for over a year-and-a-half in Canada, Target (NYSE:TGT) has finally decided to shut its operations in the country. The retailer’s debut in the market was disastrous, as it invested around $4 billion setting up its Canadian operations, and clocked up over $2.5 billion in losses in less than two years. ^[1] Target recently stated that given the present conditions, it may not see profits until 2021, and hence there is no point continuing in the market. The retailer’s exit from the country continues a cascade of sizable financial events, including the $6.5 billion in investments and losses it has posted to date, plus costs related to store closures, minus whatever it can salvage through liquidation of assets. Target expects to take a profit hit of close to $5.4 billion in Q4 mainly related to write-down of its investments. In 2015, Target will report $275 million in pre-tax losses. ^[2]

Brian Cornell, who was appointed the CEO of the company last year stated that exit from Canada will allow to company to focus on its core business in the U.S. In the aftermath of the massive data breach, Target found its extremely difficult to attract customers who were skeptical about their credit/debit security. However, the company has gradually brought its customers back and it now wants to focus solely on sustaining this improvement. The cheap chic retailer recently stated that its holiday sales were better-than-expected and it now expects Q4 comparable sales in the U.S. to increase by 3%, one percentage point ahead of its earlier guidance. ^[2]

While the abrupt exit from Canada won’t be cheap, Brian Cornell will have one less thing to worry about as he looks to devise revival strategies for the company. Target Canada would not have been profitable any time soon and the Canadian retail market is not conducive enough for the company to persist with such losses. Therefore, it does not make sense to continue investing in the country. We believe that what the exit is costing Target now is significantly less than what it would have lost in the years to come. We believe that the discontinuation of operations was probably the best way out of Target’s Canadian debacle. However, this makes it almost evident that Target may not want try another international venture any time soon.

Our price estimate for Target stands at $70, implying a discount of less than 10% to the current market price. We will update our model after the company comes out with is new reporting structure at the end of Q4.

See our complete analysis for Target

How Target Started In Canada And What Led To Its Demise

Target had high hopes from Canada when early in 2011, it announced the plans to buy leases for 220 Zellers stores (a major discount department chain at that time) for C$1.82 billion. Later, the company revealed that it had acquired leases for only 189 Zellers locations, and was in the process of renovating them. In March 2013, Target finally launched its first three test stores, and ended the year with a massive fleet of 124 locations. When the company announced the discontinuation of its Canadian operations, it had 133 stores operational.

Target believed that it was a popular brand name in the country, but it may have failed to comprehend the fact that serving Canadian buyers is a difficult task, despite the similarity in their taste with American consumers. Cross-border shopping in Canada is very popular due to duty free exemption. Due to this, Canadian buyers cross the border and buy products at cheaper prices in the U.S. Offering products at similar rates in Canada is difficult, due to high transportation and distribution costs, and difference in tax rates and duties. What Target offered in Canada proved to be too expensive for consumers and the retailer’s sluggish supply chain made things worse. Due to Canadian packaging laws, protectionist tariffs on certain food products and exclusive wholesale agreements, Target’s U.S. network could not serve its Canadian business. Hence, the retailer had established a fresh supply chain network for Canada, which was inefficient.

According to a survey conducted by Forum Research in 2013, only 27% of the customers polled were “very satisfied” with their experience at Target. Others felt that the products were too expensive and the retailer was unable to meet customer demand, as a lot of products were out of stock. Products that were in-stock, weren’t inline with the customer preferences. As a result, the company had to usher heavy markdowns to clear its store inventory, which in turn reduced its gross margins. With paltry gross profits, high start-up costs including compensation, benefits and third-party service expenses, Target Canada reported significant losses for consecutive years.

The Exit

Soon after Brian Cornell joined Target, he began reviewing the company’s loss making Canadian business, in order to come up with some relevant strategies. However in a recent update, he stated that “we were unable to find a realistic scenario that would get Target Canada to profitability until at least 2021”. Another six years of losses would have meant that the company would be burning a significant portion the cash generated from its U.S. business, which itself is struggling. Hence, rather than spending on Canada, it makes sense for the management to focus solely on the U.S. business. Target believes that this decision will have a positive impact on its earnings going forward, and hence shareholders should not worry about the company’s sudden exit from North of the border.

Target Canada had filed an application for protection under the Companies’ Creditors Arrangement Act (the “CCAA”) with the Ontario Superior Court of Justice (Commercial List) in Toronto (the “Court”), and it has already received an initial order for CCAA. It will most likely sell its remaining assets to rivals Wal-Mart (NYSE:WMT) Canada, or Loblaw Cos. Ltd or Hudson’s Bay Co, and would make cash contributions of $59 million into an Employee Trust. ^{[3] [2]} Henceforth, Target will operate under a single segment that includes its entire U.S. operations.

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1. Target To Exit Canada After Failed Expansion, The Wall Street Journal, Jan 15 2015 [↩]
2. Target Corporation Announces Plans To Discontinue Canadian Operations, Target, Jan 15 2015 [↩] [↩] [↩]
3. Target could sell Canadian assets to Wal-Mart of HBC, analyst speculates, The Globe and Mail, Oct 22 2014 [↩]