Target (NYSE:TGT) had initiated its international expansion last year, when it opened its first store in Canada. The company had substantial faith in the country’s retail market along with its brand image, which is evident from the fact that it established a giant fleet of 124 stores within a single year. However, the retailer expanded aggressively in the region without setting up an effective supply chain to supplement its needs. Due to Canadian packaging laws, protectionist tariffs on certain food products and exclusive wholesale agreements, Target’s U.S. network cannot serve its Canadian business. Hence, the retailer had established a fresh supply chain network for Canada, which wasn’t too efficient.
Due to this, customer response to Target was much worse than the cheap chic retailer expected, which resulted in low store traffic and subsequently, heavy markdowns. To make things worse, high preopening expenses weighed heavily on the retailer’s profits, and it reported substantial losses during the first year of its operation. Even this year, Target Canada remains a loss making business on account of sluggish topline growth and high expenses. The root of all problems is the lack of a strong supply chain system and the retailer is looking to address this issue now. Since the retail landscape in Canada is highly developed, we believe that competition will be a big factor playing on Target’s mind as it looks to rectify its shortcomings.
Our price estimate for Target stands at $70, implying a discount of less than 10% to the current market price.
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Back in 2010, Target had announced its interest in expanding internationally, and it was almost certain that Canada would be its first destination. Early in 2011, the retailer had said that it would 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. Of these 189, Target had decided to renovate 125-135 into its iconic red and white format, and sell the remaining locations to other retailers, including Wal-Mart (NYSE:WMT) Canada. After spending a significant amount on renovation, the company finally launched its first three test stores in March, and added another 17 later that month. Target opened a significant number of stores between September 2013 and November 2013, and ended the year with 124 locations. A number of the retailer’s stores included a Starbucks (NASDAQ:SBUX) outlet within.
Serving Canadian buyers is an arduous 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. Target learnt this the hard way, as its aggressive foray in Canada turned into a disastrous failure.
Target invaded the Canadian retail market with a massive store fleet, even when it did not have a sound supply chain to back its needs. Canadian shoppers weren’t satisfied with their experience at Target due to high prices, out of stock products and a poor selection of merchandise. According to a survey conducted by Forum Research last year, 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, that routed its gross margins.
Target generated a total of $1.31 billion revenues in fiscal 2013 from its Canadian operations with gross margins low at 14.9%. In contrast, the retailer’s gross margins in the U.S. were around 30%. Overall, the Canadian segment clocked up $941 million in losses due to high start-up costs including compensation, benefits and third-party service expenses. During the first nine months of fiscal 2014, the segment’s revenues totaled at $1.32 billion, that was actually more than what it generated in the entire last year. However, this can be attributed to fact the Target had just 91 stores operational at the end of Q3 fiscal 2013, compared to 133 stores at the end of the same quarter this year. Its comparable sales for the nine month period declined 3.3%, which is not a good sign for the company. Target’s gross margins fell 4.5 percentage points for the nine month period and high SG&A expenses related to start-up costs continued to suppress its profits. Target’s total losses were at $627 million at the end of the nine months of fiscal 2014, which was actually a little higher than $612 million recorded in the year ago period. With losses increasing and comparable sales not being positive, there aren’t any visible signs of recovery.
In a business update earlier this year, Target had mentioned that its Canadian team was in the process of reviewing its last year’s performance to find out what went wrong. Based on customer feedback, the retailer had identified some areas, where it needed to rectify its shortcomings. Target quickly turned to its supply chain, which had been at the base of all its problems. It was also reviewing its prices, which according to customers were too high. When Target entered Canada, buyers were expecting its prices to be comparable with Target U.S., but they were expensive. In its update, Target had stated that it is ready to take necessary actions to quickly adapt to the Canadian pricing dynamics. The cheap chic retailer had launched its price match strategy in Canada, where buyers can match merchandise prices at Target with Amazon.ca and Walmart.ca. The company had also decided to add new product lines to its shelves, which buyers could not find last year. Target had planned to add about 30,000 new SKUs by the holiday season, which would have brought its total to 70,000 SKUs. 
Target’s demand forecasting in Canada was a little botched up in the beginning, which is why it faced inventory surplus issues, even when buyers said that the merchandise they were looking for were not in stock. To prevent its recurrence, Target is planning to employ better reporting structure that can identify its inventory needs effectively. It is retraining its staff to use best methods to push inventory through the system and is working on developing new methods specifically tailored for Canada. A while back, Mr. Schindele had commented during his tour of Target’s Toronto stockyards, that the company is pushing more inventory than the system deems fit in its top performing stores. The program, internally known as “how high is high”, is pushing Target’s top 20 outlets to their limits, to find out how well they can perform amid the ongoing turnaround efforts. It appears that the retailer is willing to take the risk of over-stocking its best outlets, to recognize their true capacity. Once Target successfully gauges the potential of its top outlets, it can plan accordingly for the remainder of its stores.
In addition to this experiment, Target is taking several steps to ensure quick and effective replenishment of its shelves across the entire network. Employees are being given as much as six hours to unload inbound trailer trucks, and stock stores and back rooms effectively, as a part of the “coming clean on trailers” program. The staff is being instructed to check each four foot section of a particular store every two weeks, to make sure everything is in order. “Green zones” are being set up to help employees stock products exactly at the right location within the specified area. With the “98 percent accuracy” initiative, in-store staff is ensuring that each room is 98% stocked at all times, making it easier to track the quantity of different items. 
Although individually these initiatives may not look too convincing, their effective execution and proper integration can help Target gradually augment its supply chain network, which has been its biggest concern since its debut in the country. Mr. Schindele had said that the company has already made significant progress on effective stocking of categories such as beauty and health goods, household staples, toys and electronics, but shoes, handbags and home goods still need some attention. Since an efficient supply chain is the foundation of any FMCG (i.e., Fast Moving Consumer Goods) business, it appears that Target is focusing its efforts on the right facets. However, their impact is yet to be seen.
View Interactive Institutional Research (Powered by Trefis):Notes:
- Target Reports Second Quarter 2014 Earnings, Target, Aug 20 2014 [↩]
- Target Canada to experiment with over-stocking in turnaround effort, The Globe and Mail, Oct 22 2014 [↩]