Target Slashes Its Q4 Outlook And Unveils Plans To Close Eight Stores

by Trefis Team
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Quick Take

  • In its recent business update, Target lowered its EPS guidance for the fourth quarter on account of poor comparable store sales
  • A heavy decline in foot traffic weighed on Target’s sales, forcing it to project a decline of 2.5% in Q4 comparable sales
  • The company was unable to benefit from the surge in online orders during the holiday season as its e-commerce channel is small
  • Target stated that the data breach (revealed in mid December) was also responsible for its weak sales
  • The retailer also unveiled plans to close eight underperforming stores, which might be the start of store consolidation
  • If Target does pursue this strategy, there can be a potential 10% upside to its value

Target (NYSE:TGT) recently lowered its EPS guidance for the fourth quarter from $1.50-$1.60 to $1.20-$1.30 on account of weaker-than-expected sales. [1] Due to a significant decline in U.S. store traffic, several retailers (including Target) struggled with their sales during the recently concluded holiday season. Moreover, U.S. buyers were particularly hesitant with their spending on apparel, which is a big product category for the company. Although Target has registered positive comparable store sales growth in the last few quarters, it is projecting a decline of 2.5% for Q4 fiscal 2013. This can be attributed to the fact that U.S. buyers bought more online during the holiday season and Target does not attract significant web traffic. Additionally, the company said that the mid-December data breach also played a part in its weak results. Indeed, its holiday sales were disappointing.

In addition to the aforementioned updates, Target announced plans to close eight of its stores in the near future after reviewing their financial performance. While this is not a very significant development in itself, it might be the start of a store consolidation. The company operates more than 1,800 stores in the U.S. and not all are running at their full capacity due to self-cannibalization. Assuming that the company continues to identify and close its underperforming stores in the future, its store productivity can improve.

Our price estimate for Target stands at $74, implying a premium of around 20% to the market price. See our complete analysis for Target

Store Traffic Decline And Lower Spending On Apparel Weighed On Target’s Sales

Pressured by increased taxes, slow job growth, higher healthcare costs, and certain other political and macro-economic factors, U.S. buyers spent very cautiously last year. This trend was more profound during the holiday season as the U.S. retail industry saw its weakest growth since 2009. Moreover, extreme weather conditions prevented buyers from completing their shopping. As a result, U.S. foot traffic declined by 19.9% for the week ended December 15, and 21% for the week through to December 22. Overall, foot traffic during the holiday season decreased by a staggering 14.6%, which was significantly higher than ShopperTrak’s prediction of 1.4% decline. Furthermore, while U.S. buyers spent freely on electronics, furniture and building materials, they were reluctant to spend on clothing. A Reuters poll conducted before the holiday season found that about 27% of the consumers had planned to spend less on apparel this holiday season. Since Target earns close to one-fourth of its revenues from apparel, it was at the receiving end of this trend.

Shopping Preference Shifted Online And It Din’t Favor Target

Despite the heavy fall in foot traffic, U.S. retail sales managed a modest growth of 2.7% during the months of November and December. [2] This is attributable to the fact that U.S. buyers moved their shopping online since extreme weather conditions kept them away from stores. Before Christmas, ShopperTrak predicted that U.S. store traffic will decline by almost 10% on this holiday as compared to last year. However, the decline in store traffic somewhat complemented the strong rise in online orders just before December 25. The surge was such that United Parcel Service (NYSE:UPS), one of the largest players in e-commerce delivery, was unable to deliver several orders on time. Also, apparel retailer Abercrombie and Fitch (NYSE:ANF) saw the revenue share of its online business rise from 16% to 25% in December.

While this trend favored the retailers who drive substantial web traffic, players with smaller e-commerce channels were unable to benefit from it. For Target, online revenues account for an immaterial portion (does not report) of its overall sales. Therefore, even if the retailer’s online revenues had increased substantially during these two months, a heavy fall in foot traffic would have easily subdued its impact.

Data Breach Also Impacted Target’s Sales

Half way through the month of December, Target revealed that criminals broke into its database and took guest information including credit card/debit card data along with names and email ids of over 70 million customers. In its recent business update, the company stated that while its sales were going better-than-expected before the breach, they have been meaningfully weaker since. [1] We believe that customers moved away from Target as they felt that their credit card/debit card security had been compromised.

Later, Target sent an email to its guest apologizing for the breach. [3] It also assured its customers that they had zero liability for the cost of any fraudulent charges resulting from the breach. As an effort to revive its customers’ confidence in the company, Target is offering one year of free credit monitoring and identity theft protection. [4] The data breach may have impacted Target’s sales during the holiday season, but its impact will subside as customers gradually return to the retailer.

Is Target Looking At Consolidation?

In its business update, the company stated that it plans to close eight stores in the U.S. in May since their financial performance were not up to the mark. While the company has not provided any further information related to this matter, we believe that it might be employing a store consolidation strategy.

Due to its vast presence in the U.S., the retailer operates a certain number of stores that are cannibalizing each other’s sales. Therefore, along with expanding new, smaller format stores in urban markets, Target might be considering relocating or closing its underperforming stores. Though the company earns a huge amount of revenues from its domestic business (over $70 billion), its EBITDA margins are low at around 11%. Moreover, costs related to its Canadian expansion are further eating away its profits. Therefore, it is clear that Target needs to focus on gradually reducing its selling general & administrative expenses (SG&A) as a percentage of revenues, which can be done by improving store productivity. Along with developing its online channel, and attracting customers through more groceries and rewards programs, having fewer underperforming stores may serve the purpose.

We currently forecast Target’s SG&A (as a percentage of revenues) to gradually decline to 16.9% over the next five to six years due to operating leverage. Assuming that the company continues to close underperforming stores and brings the aforementioned figure down to 16.5%, there can be about 10% upside to our price estimate. However, it still remains to be seen if the company is actually planning to pursue this strategy or not.

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  1. Target Provides Update On Data Breach and Financial Performance, Target, Jan 10 2014 [] []
  2. U.S. retail sales up 2.7% in 2013 holiday season: ShopperTrak, The Economic Times, Jan 8 2014 []
  3. “We’re sorry you got hacked”: Target’s letter to unlucky customers, Marketplace, Jan 16 2014 []
  4. an update on our data breach and financial performance, Target, Jan 10 2014 []
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