More than other factors, Target‘s (NYSE:TGT) revenue per square feet (RPSF) (a measure of the retailer’s store productivity) has been influenced by the economic environment in the U.S. During the economic downturn of 2008-2009, the retailer’s RPSF declined substantially as U.S. buyers spent less on discretionary products. However, with gradual economic recovery, the figure increased consistently from $279 in 2009 to $304 in 2012. In 2013, Target’s RPSF declined marginally to $298 owing to an overall weakness in the U.S. retail industry as well as the data breach that impacted the retailer’s sales in the fourth quarter.
Going forward, we expect Target’s RPSF to improve at a moderate rate for the next five-six years driven by increasing REDcard adoption, growth of online business and expansion of smaller format stores. Target’s customers have been increasingly switching to REDcard shopping to avail discounts and have spent more than regular customers. Although the retailer’s e-commerce channel is still at a nascent stage, it has done exceptionally well over the past several quarters. We believe that Target’s strategies to bolster its online channel will make it strong enough to make a material contribution in the future. Also, the company is looking to ramp up its smaller store expansion, which is likely to have a positive impact on its RPSF.
Soaring REDcard Penetration – Increased Spending At Target
Target’s REDcard and pharmacy rewards programs have been very important in attracting value conscious customers. The 5% reward loyalty program allows customers to save money when they shop at Target stores. The company has stated that its REDcard customers tend to visit twice as often as its regular customers and spend about 50% more. Over the past four years, there has been a significant increase in the total REDcard penetration. From 5.9% in 2009, the figure jumped to 13.6% by the end of 2012. Interestingly, REDcard penetration soared to 19.3% in 2013 as U.S. buyers became extremely cost conscious, pressured by increased taxes, slow job growth, higher healthcare cost and gasoline inflation.
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With rising popularity of REDcard shopping, we expect greater store traffic and consumer spending at Target, which will aid its comparable store sales growth. Additionally, the company’s relatively new loyalty program (pharmacy rewards) might also have some positive impact. Pharmacy guests have shopped at Target stores about three times more often and spent 50% more than non-pharmacy guests.
Although U.S. buyers have been reluctant to spend at Target lately in wake of the recent data breach, we expect its impact to subside gradually. Target is taking several steps to regain shoppers’ confidence and prevent the recurrence of such events. It has ensured zero liability for any fraudulent charges to its customers. The company has also increased fraud detection for REDcard holders along with credit monitoring and identity theft protection. 
Improving Online Business – Significant Contribution In The Future
Although Target’s e-commerce business does not contribute much to its overall revenues, the channel is quite strong. During the last year’s holiday season, the retailer registered healthy revenue growth in its digital channel. Through most of last year, Target’s digital traffic and sales remained ahead of the industry averages. Interestingly, the retailer’s mobile app was the most browsed app on smartphones and tablets in 2013. Mobile Commerce Daily even named Target Mobile Retailer and Commerce Website of the year. Since the digital channel currently accounts for an immaterial portion of Target’s sales, the cheap chic retailer is working hard to make it a bigger business. 
Target is utilizing digital technology to create an appealing online and mobile shopping experience. Through rigorous testing, integration, partnerships and by learning ways to increase the speed to market, the retailer is looking to respond to its customers’ needs in a prompt manner. During 2013, Target hired several external leaders with strong backgrounds, to work on developing its Target.com and mobile channel. Alongside, the retailer is working on its product portfolio to provide its customers with a wide variety of merchandise online. During its November financial community meeting, Target stated that all of its store products including groceries will be viewable online within a month’s time. The company has also launched some online exclusive products such as Tevolio collection and added new categories with acquisitions such as CHEFS Catalog, Cooking.com and DermStore Beauty Group. 
Target’s mobile saving tool Cartwheel, launched in partnership with Facebook last year, has found tremendous acceptance among customers. Since its inception, more than 5 million users have signed up and saved over $43 million. Encouraged by this, Target is planning to make further enhancements in Cartwheel along with increased investments in flexible order fulfilling to improve the customer service. In November 2013, Target launched in-store pick up service (order online and pick at stores) throughout its store fleet. Within a quarter, this service accounted for about 10% of the total online orders. Interestingly, close to 30% of the customers who visited stores to pick up their online orders ended up buying more. This implies that customers’ online shopping interest is helping Target enhance its store sales. Towards the end of 2012, the company entered a partnership with online retailer eBay to use its marketplace to offer Target products. The retailer initially started with 150 SKUs, which it increased to over 100,000 in the recently concluded holiday season. Target stated that this strategy has brought in a fresh customer base and it represents a new revenue stream.
Smaller Format Expansion – Higher Sales In A Limited Space
Target introduced its smaller format concept CityTarget for urban markets about a couple of years ago. A CityTarget stores 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. CityTarget stores have performed very well so far and they delivered high-single-digit comparable store sales growth throughout their second year of operation.
In response, the company is developing a separate small format known as Target Express, which is about 15% the size of a general merchandise store. Target is planning to offer private label daily need products such as food, healthcare, beauty and other household essentials in these stores.  This strategy appears to be inspired by the tremendous success of Wal-Mart’s smaller stores in the U.S. Target will pilot its first Target Express store in July this year, and will plan the format’s expansion based on its performance.
As the company operates close to 1,800 stores in the U.S., it is likely to slow down the expansion of its typical big box stores. We believe that Target will look to expand its small stores instead, considering the huge opportunities in urban markets. Gradually, this will result in higher penetration of smaller stores in Target’s overall store fleet, which should lift its RPSF.
How Sensitive Is Target’s Stock Price To Its RPSF?
We currently forecast Target’s U.S. revenue per square feet to increase from $298 in 2013 to $365 by the end of our forecast period. However, if faster than expected economic recovery combined with these efforts push the figure to $385 instead, there can be more than 5% upside to our price estimate. Conversely, if economic growth remains sluggish, impact of data breach lingers longer than expected and these efforts fail to bear fruit, limiting RPSF to $340, there can be about 5%-10% downside to our price estimate for Target. Although the company is working hard to improve its comparable store sales, the economic environment in the U.S. will continue to play a crucial role in driving its RPSF.