If you follow my articles, then you know that I'm not bullish on most retailers. There isn't much reason to be optimistic considering all the headwinds the consumer faces, including increased payroll taxes, high gas prices, underemployment, and rising mortgage rates. However, some retailers offer a little more safety because they focus more on what people need instead of what they want. Target (NYSE: TGT ) fits into the latter category.
In the second quarter, sales increased 4% to $17.12 billion year over year. U.S. sales improved 2.4% to $16.84 billion. Target opened 68 new stores in Canada in the first half, as well as 10 new stores in the United States, which aided the top line. Looking at the bottom line, diluted earnings-per-share declined 10.4% to $0.95.
Target plans on opening a total of 124 stores in Canada in 2013, which should continue to boost top-line performance. However, there will be expenses associated with these openings which will impact margins. This fact, combined with increased competition and a tentative consumer, is likely to impact Target's profitability. For instance, Target now expects FY 2013 earnings-per-share to come in at the lower end of the following range: $4.70-$4.90, citing household budgetary constraint.
Good news on the top line and bad news on the bottom line can lead to confusion. Therefore, we need to take a look at the most important metric -- comps.
The most important number in retail
For Target, comps include stores that have been open at least 13 months. Overall, comps increased 1.2%. At first glance, this looks positive. However, it does indicate declining sales growth at established stores because comps grew 3.1% in the year-ago quarter. The number of transactions at comparable stores also declined 1.4% compared to a 0.7% increase in the year-ago quarter. The good news is that average transaction amount and selling price per unit both performed better year over year, showing improvements of 2.7% and 1.6%, respectively. In the year-ago quarter, these numbers grew at 2.4% and 1.1% clips. Units per transaction improved 1% which was not as fast as the 1.3% rate seen in the year-ago quarter.
The takeaway is that not as many people are visiting Target stores. Those who do visit Target stores spend more money than they did a year ago. This likely has to do with Target's ability to identify what consumers need (and want). Broad product diversification doesn't hurt, either. High gas prices might also be a factor -- consumers aren't as likely to store hop as they were in the past. Consumers want to shop all in one place, which Target offers.
The picture still isn't crystal clear. Target is good at generating cash flow, which it uses to pay off debt, invest in its existing business, and reward shareholders via dividends and buybacks. These are all positives. In the second quarter alone, Target spent $231 million in dividends and $927 million in buybacks. Currently, Target yields 2.70%.
Another positive is that Target's REDcard penetration has increased to 18.7% from 12.8% in the year-ago quarter -- a sign of improved customer loyalty.
With regards to growth potential, Target is making strategic moves by expanding in Canada (healthier consumer than in the U.S.) and opening CityTarget stores. This has enormous potential, since it's likely to attract a lot of foot traffic.
Target vs. peers
Target has clearly established an effective strategy. The company's marketing and brand are both strong, growth is likely, and cost management is good. However, that doesn't guarantee it's the best investment option in its peer group.
Costco (NASDAQ: COST ) , has extremely loyal customers, thanks to a top-tier shopping experience as well as geographical and product diversification. Costco's June and July comps improved 4% and 6%, respectively, year over year. Costco should continue to reward its shareholders. A 1.10% yield is an added bonus.
Wal-Mart (NYSE: WMT ) is by far the largest of the three, sporting a market cap of $238.84 billion, versus a market cap of $40.18 billion for Target and a $48.80 billion market cap for Costco. Wal-Mart's size, global exposure, product diversification, and brand diversification with Sam's Club give it tremendous resiliency to any market weakness.
Target has been attempting to steal market share from Wal-Mart in the grocery category with its PFresh brand, but Wal-Mart has already established such an enormous presence in groceries that it will be difficult for Target to see meaningful progress.
That said, with Costco's recent run-up, it is now trading at 25 times earnings, whereas Target is trading at just 15 times earnings. And Target is a much smaller company than Wal-Mart, which sports a similar P/E multiple to Target, leaving more growth potential for Target.
Despite intense competition and a weak consumer, Target has made strategic moves in order to boost its growth potential. If its Canadian expansion and CityTargets openings are successful, then Target is a great bargain here especially compared to its main competitors. Even if these initiatives under-perform, and/or if the stock market falters and drags the stock down, it's likely to present a good opportunity to buy more shares at lower levels.
The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.