Why Investors Should Be Cautious About Target

With the recent data breach Target (NYSE: TGT  ) consumers have good reason to be wary of shopping there. Target's entry into Canada last year proved less than stellar as prices were less than competitive and left customers discouraged. All of these problems resulted in eroding fundamentals and a dimmer long-term outlook. Let's explore these issues in more detail to see why investors should heed caution before investing in Target.

Data breach cost? Who knows
In the most recent earnings announcement, Target had this to say about estimated future expenses stemming from the data breach, "At this time, the Company is unable to estimate future expenses related to the data breach that occurred in fourth quarter 2013." In summary, the company went on to discuss legal and other expenses stemming from possible card reissuance expense, "REDcard fraud", "government investigations", capitalized expenses for remediation activities, etc. 

Consumers, who lost faith in the company, will think twice before shopping in a Target. Target loses out on consumer engagement and the use of valuable demographic data that comes from consumer usage of the card, making it more difficult for the company to make decisions when catering its selection to customers.

Low price leader? Not in Canada
In March 2013, Target decided to enter Canada in order to expand its global presence.  This proved disastrous for the company. The Canadian division lost $941 million before interest and taxes in 2013.  The red ink continued in the most recent quarter with the division losing $211 million more before interest and taxes. 

The culprit lies in higher merchandise pricing in comparison to its competitors and other Targets near the U.S./Canadian border. Target's Canadian expansion is now hampered by a disgruntled consumer base in the country and it now faces the added task of winning customers back in addition to figuring how to expand its market presence in the country.

Management turnover may serve as a temporary deterrent to resolving these problems as new managers settle into their new roles. Target's former CEO Gregg Steinhafel was fired by its board of directors and replaced by interim CEO John Mulligan.  The president of Target Canada Tony Fisher got replaced by Mark Schindele, Target's former senior vice president of merchandising operations.  Target also made a myriad of lower level management changes as well. 

Fundamentals
Target's annual revenue only expanded 11% over the past five years. Its net income and free cash flow were down 21% and 26% during the same time frame.  During the most recent quarter, the company expanded its revenue 2%.  New stores contributed to top line growth. Net income declined 16% while free cash flow registered at a negative $36 million  during the most recent quarter. A declining number of transactions in the U.S. most likely stemming from the data breach and inventory markdowns in Canada as a result of pricing issues contributed to Target's erosion of fundamentals. 

What should you do?
Investors may want to sit back and see if management can turn things around. Target needs to work on making itself more price competitive in Canada. Moreover, Target needs to get creative and work diligently on gaining back the trust of its consumers. This represents a difficult task. Target's customers may never hold the same level of trust as before the data breach. Only time will tell.

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