Target Corporation (NYSE: TGT ) reported a steep drop in Q1 earnings last week, as expected. The company's two big blunders of 2013 -- the botched Canadian expansion and the data breach -- are still weighing down its performance.
However, considering where Target was just a few months ago, the company appears to be bouncing back. It is starting to fix its weaknesses in Canada, helping sales and margins to recover. Meanwhile, revenue is holding up well in the U.S., although profitability is under pressure.
Most importantly, Target's ongoing management shakeup shows that the board of directors is finally taking a more active role in laying the foundation for a turnaround. This means that it's finally time for value investors to consider buying Target stock.
Sales returning to the flat line
During Q4 of 2013, Target started to build up some momentum in the U.S., as comparable-store sales increased during the early holiday shopping season. However, comparable-store sales trends turned sharply negative after Target confirmed that customer information had been lost in a data breach. The net result was that comparable-store sales declined 2.5% for the full quarter.
In February, Target projected that comparable-store sales in the U.S. would decline 0%-2% in the first quarter. In other words, the trend would improve sequentially while remaining negative. Luckily, Target nearly hit the high end of the forecast, with U.S. comparable sales down just 0.3% in Q1.
While a comparable-store sales decline is never good, the sales declines could have been a lot worse considering that the data breach occurred just a few months ago. Furthermore, Wal-Mart (NYSE: WMT ) experienced a 0.6% decline in U.S. comparable-store sales last quarter -- and it didn't have to contend with the same type of reputational issues.
Wal-Mart's ongoing struggles show that big-box discounters still have to contend with serious long-term issues related to Americans' shopping habits. On the other hand, Target's ability to leapfrog Wal-Mart in terms of sales momentum suggests that its plan to regain customers' trust is working, and that it may have a better strategy for navigating the changing retail landscape.
Driving a turnaround
In the U.S., time should heal many of Target's wounds. Guest surveys indicate that most consumers are resuming their previous Target shopping habits. This is supported by improving sales trends in the U.S.
To keep customer traffic up, Target is "investing in price" -- i.e., offering bigger discounts than usual. This is cutting into the company's profit margin. However, if these price investments catalyze a return to sales growth, they may be sustainable. It is also working on other initiatives to jump-start sales growth, such as "ship-from-store" capabilities.
Similarly, Target's subpar performance in Canada is fixable, but it will take time to get back on track. Target expects a 25% sequential increase in sales in Canada this quarter, which is one good sign. The company is also fixing early supply chain issues that have caused gluts of some items and shortages of others.
Target's gross margin in Canada has started to recover, reaching 18.7% in Q1, up from just 4.4% in the prior quarter. This marks the beginning of what will probably be a two- to three-year slog to reach profitability in Canada. Nonetheless, Target's losses in Canada should shrink quarter by quarter and year by year, helping the company to return to profit growth globally.
Target still has a long road ahead of it to return to its historical level of profitability in the U.S. and reach breakeven in Canada. However, it's good to see that Target posted better sales results than top rival Wal-Mart in Q1, considering that the data breach was discovered less than two months before the quarter began.
This bodes well for Target's ability to return to comparable store sales growth soon -- whereas Wal-Mart's return to growth will probably take longer to materialize. Target still has to deal with some major issues, most notably compensating credit card companies and consumers for fraud claims. However, these costs should be manageable.
Target shares are down more than 20% from the highs of last summer. With sales momentum starting to improve, it now looks like an intriguing opportunity for value investors. I'm not pulling the trigger just yet, but I am adding Target to my watchlist.
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