Where Can Target Expand After Facing Disappointment In Canada?

by Trefis Team
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Trefis
TGT
Target
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Quick Take

  • Target started international operations earlier this year with Canada, but initial results have been disappointing
  • Nonetheless, we expect Target to continue to expand in Canada and seek other global opportunities
  • Brazil and Mexico appear as the most viable options with their immense market potential
  • As attractive merger options slacken in Brazil, it’s the right time for Target to enter the region
  • While the retail market trends in Mexico support Target’s business model, fierce competition from Wal-Mart will be a roadblock
  • There is a potential upside scenario if Target decides to expand aggressively in these markets

Target (NYSE:TGT) initiated international expansion at the beginning of fiscal 2013 as it opened its first store in Canada. Although the company has expanded aggressively since then, it has yet to see good results in the region. High pre-opening expenses have weighed on its profitability, and improper inventory management have led to poor customer response. While the impact of start-up costs will subside in the future, inventory management will remain a worry.

Despite this, we do not expect Target to halt or slow down its international expansion. We believe that it will continue to expand in Canada and look for other global opportunities. At this point, big Latin American markets of Brazil and Mexico seem to be the most viable options for Target. Although there are no concrete plans yet, the retailer had indicated in 2010 that its global expansion will most likely start with Canada, Mexico and other Latin American markets. [1] In this analysis, we take a look at why it makes sense for Target to expand in Brazil and Mexico. This appears to be a good time to invest in Brazil as potential merger options are diminishing and major global sporting events are just around the corner. Although Target will face stiff competition from Wal-Mart in Mexico, the region’s huge market potential can encourage a near-term entry.

Our price estimate for Target stands at $74, implying a premium of more than 15% to the market price.

See our complete analysis for Target

A Good Time To Invest In Brazil

BRIC nations (Brazil, Russia, India & China) have become key markets for foreign retailers to invest. Retail giant Wal-Mart (NYSE:WMT) entered Brazil in 1990s and still continues to grow at a healthy pace. French grocery giant Carrefour, which started operations in Brazil in 1975, was among the early movers in the region. Last year, another French retailer Casino began with the acquisition of Brazil’s biggest supermarket operator, Companhia Brasileira de Distribuição SA, to further strengthen its position. These three retailers account for one-third of the region’s total grocery sales, indicating that foreign companies are taking the Brazilian market seriously. [2]

In anticipation of high retail sales during the upcoming 2014 football world and 2016 Olympic games, several retailers are investing heavily in store expansion and increasing their selling space. Additionally, e-commerce has seen strong growth in Brazil over the past few years, which is good news for the retail industry. Many retailers are looking to bolster online sales and provide better customer service as a way to acquire a loyal customer base. Also, a number of companies are investing more in their supply chains to improve their distribution and delivery methods. As more retailers try to improve their services, online retailing will continue to grow and help the region’s retail industry. Furthermore, it will allow big retailers such as Wal-Mart and Target (when it enters) to fight off competition from local store-based retailers. [3]

Brazil’s retail industry is witnessing some consolidation due to mergers and acquisitions. This is likely to slow down going forward as attractive merger options decline. Delays in expansion plans will only reduce Target’s chances of finding a good company to collaborate with.

Mexico Is An Attractive Market For CityTarget Stores

Historically, Mexico’s retail market has remained strong as the region has sustained economic growth and kept inflation under control. Financing and consumer credits have emerged as important retailing tools in Mexico, and several retailers have evolved into financing bodies by providing the option of deferred payments. “Meses sin intereses,” or monthly payments with no interest, has become a common practice in the market. Last year, the market growth even exceeded GDP growth with strong performances from department stores and specialty retailers. [4] During 2007-2012, retail sales in Mexico grew at a compounded annual growth rate of 3.5%. Moreover they are expected to grow by about 5% annually (CAGR) through 2017. [5]

Over the past few years, many retailers have expanded across Mexico while specifically targeting regions with heavy footfalls. This has bolstered the popularity of smaller format and quick-stop stores. Target can easily adapt to this trend with its CityTarget format. Along with store expansion, department stores and other grocery retailers are expanding their product portfolios to meet customer demand and outperform local retailers. Since Target already offers a wide range of products, it is likely to benefit from this trend. [4]

Although this year hasn’t been the best for the Mexican retail industry, due to the economic slowdown, it still remains one of the most important global market for retailers. Retail giant Wal-Mart operates close to one-fourth of its global store fleet in Mexico, which indicates the market’s potential as well as a tough competitive environment for Target.

These Markets Present A Small Upside Scenario

Although Target has not laid down any firm plans for global expansion apart from Canada, we believe it is only a matter of time before it decides to enter Brazil and Mexico. Their close proximity to the U.S. and strong retail markets make them the most lucrative options for the retailer.

Target’s international business accounts for just 3% of its value, as per our estimates. We currently forecast Target to expand moderately and open 25 stores (on average) every year for the next five-six years. However, if it decides to expand aggressively in Mexico and Brazil and enters some other markets as well, its store growth will be significantly faster. Due to this, if Target’s international store count towards the end of our forecast period reaches close to 800 instead of our current forecast of 300, there can be 5% upside to our price estimate. This scenario is quite possible if the company sees some success in its new markets, unlike Canada.

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Notes:
  1. Opportunities include remodel, new locations, smaller format, and growth outside the U.S., Target, Jan 21 2010 []
  2. Analysis: Why have so few retailers entered Brazil, Retail Week, Aug 30 2012 []
  3. Retailing in Brazil, Euromonitor, Apr 2013 []
  4. Retailing in Mexico, Euromonitor, Feb 2013 [] []
  5. The Future of Retailing in Mexico to 2017, Report Linker, Aug 2013 []
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