These 3 Trends Will Define Target’s Future

Target (NYSE: TGT  ) started 2013 with big plans to expand into Canada, and investors envisioned additional growth and profits would follow. However, those plans didn't go as expected and earnings suffered. Just as Canada might begin to improve, a data breach hit the company's reputation. After Target reported somewhat better-than-expected fourth-quarter results, the stock has rallied. But long-term there are three trends that should define the company's future.

Investors left seeing RED
Many investors who bought Target's stock in the last year are still seeing red when it comes to their investment. However, it's the company's REDcard that is one of the trends that could drive sales growth in the future.

The REDcard is Target's answer to offerings like Amazon.com's (NASDAQ: AMZN  ) Prime service. Amazon says it has "millions of Prime members" who pay $79 a year to get free two-day shipping, streaming videos, and more. However, REDcard holders get free shipping on any online order and 5% off their entire purchase.

Wal-Mart Stores (NYSE: WMT  ) offers "everyday low prices," but at present the retailer offers little in the way of competition for the REDcard. The company has a partnership with Discover that offers 1% cash back, and in order to get free shipping you must spend $50.

According to Target's third-quarter conference call, customers who have the REDcard "increase their spending by about 50%." With a domestic penetration rate of 21% and a Canadian penetration rate of slightly more than 3%, there is plenty of room for Target to continue helping its customers see the value of some red in their wallets.

To demonstrate the power of the REDcard, if Target were able to increase its domestic penetration by 10%, this would theoretically add $1 billion in sales to the company's $20 billion in domestic quarterly sales ($20 bln X 0.10 = $2 bln increased by 50% = $1 billion). This increased penetration alone would add 5% to the company's top-line growth. Considering the company has grown its percentage of REDcard customers from 15% to 20% in the last year, further increases seem very likely.

Oh Canada!
To say that Target expected a lot in Canada and got a little is an understatement. The company essentially admitted it started with "too many payroll hours" and too much inventory. The good news is, the company was aggressive over the holiday season and cut its "average inventory in Canadian stores by 30% last quarter."

With Amazon reporting 13% growth in international sales and Wal-Mart reporting international sales increased by 1.3%, there is proof that companies can sell abroad. However, based on the fact that both companies grew faster domestically, Target has been forced to be more realistic with its projections for Canadian growth.

Target reported a gross margin in Canada of just 4%, and this result dragged the company's overall gross margin down to nearly 27%. However, this gross margin rate isn't likely to continue, as the inventory clearance has been largely accomplished.

The stabilization of Target's Canadian operations is the second trend that should drive sales. Target's U.S. stores generate about $1 billion in earnings before interest, taxes, depreciation, and amortization per store. Even if the Canadian stores generated half that amount, the company's earnings would improve by more than $300 million. If the Canadian stores were able to match their domestic counterparts, earnings could improve by almost $400 million. The bottom line is, Canada is a marathon not a race, and Target has a huge opportunity ahead of it.

Something to do a Cartwheel over
The third trend that should drive Target's growth in the future is the continued expansion of the company's digital and mobile presence. Wal-Mart has offered site-to-store shipping for years, and Amazon is constantly building warehouses to speed home delivery. On the other hand, Target just completed its site-to-store rollout in November. Near the end of the year, the company reported "double-digit growth in digital traffic" and "triple-digit growth in mobile traffic."

One way Target has begun to leverage its mobile strategy to garner customers' interest is through Cartwheel. This Target app has been growing quickly, as membership increased from 3 million at the end of the third quarter to more than 5 million by year-end.

Cartwheel allows customers to clip virtual coupons on products in store. With the ability to scan a barcode to see what is available, and an ever-changing selection, customer engagement is very high, with more than $43 million saved already.

The bottom line is, short-term headlines may grab investors' attention, but Target has growth in its sights. With increased REDcard penetration, better operations in Canada, and continued growth in mobile, investors currently seeing red may expect more green in their future.

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