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Canada is the new battleground for grocery stores, and a poor decision by a rival may just allow Target (NYSE: TGT ) stock to ride the express train higher.
The country that shares our northern border is proving to be a market worth fighting over. In addition to Target's expansion there earlier this year, rival Wal-Mart (NYSE: WMT ) is investing heavily, with an aggressive $450 million expansion plan. And where the domestic operations of Sears Holding are dwindling away to nothing, its partially spun-off Canadian operations have long been one of the retailer's bright spots.
So it was surprising to see that grocery story chain Safeway (UNKNOWN: SWY.DL ) chose to abandon the Canadian market altogether in an effort to focus more closely on its U.S. operations. Last week it agreed to sell its 223 stores (including 199 that have pharmacies in them) to Sobeys for $5.7 billion, and though the market initially appeared to like the move, spiking Safeway's stock higher, it seems the move will ultimately be a mistake.
Safeway's U.S. business comprised 85% of its revenues in 2012, but the Canadian operations make up a third of its operating profits and 43% of its net earnings. By jettisoning its profit center, the grocery store chain may have made a shortsighted move of taking money up front at the expense of a stronger and growing business later on. I agree with my colleague Andrew Marder, who believes Safeway is going to waste money on repurchasing shares, which only props up earnings per share while doing nothing for its underlying business.
Then again, Target's entry into the Great White North may have been the writing on the wall for Safeway. The discount department store has only been in Canada for a quarter, rolling out its first 24 stores in March -- but with another 100 planned for the rest of the year -- and already Wal-Mart is stumbling, with same-store sales falling last quarter.
But Wal-Mart's not ceding ground either, as it is planning to complete at least 37 additional supercenters by next January, bringing the total number of Canadian stores to 388. It also throws down the gauntlet to Target, whose food offerings tend to be more limited.
Another rival quietly expanding its presence up north is Costco (NASDAQ: COST ) , which has been in the country since 1985, and enjoyed a 12% boost in Canadian sales last year to $15.7 billion. Similarly, Whole Foods Market (NASDAQ: WFM ) wants to open 40 stores there and eventually achieve some $1 billion in sales.
Sure, that means the competition would be stiff for Safeway, but it also indicates there's plenty of opportunity for growth. Target, as the latest entrant, will not only steal share from its rivals, but can establish itself as a major presence. Its first 24 stores generated $86 million in sales this quarter with a gross margin rate of 38.4%, well ahead of the 30.7% rate achieved in the U.S.
With Safeway making the mistake of withdrawing from the field of battle, I think it's Target's war to lose, and I don't see that happening. Instead, expect its stock to go north on this Canadian clipper.
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