For Target, a Breach of Trust Is the Main Concern

A strange thing happened to my sister this weekend while we were shopping for Christmas presents -- her debit card was declined. She called her bank and it turns out that since she used the card at a Target (TGT 2.96%) store within the last few weeks, the bank imposed a daily limit on the card to prevent possible fraud.

This, of course, is a result of the massive data breach Target experienced within a 19-day period during the busy holiday-shopping season. The unfortunate situation has created a lot of bad press for the retailer. A concern is that it will hurt the company's brand in the long term, which is dangerous with powerful competitors like Costco Wholesale (COST 2.05%) and Wal-Mart(WMT 0.58%) lurking about.

The breach
In a recent letter issued by Target CEO Gregg Steinhafel, the executive acknowledged that the company "experienced unauthorized access to payment card data from U.S. Target stores."

The data breach occurred in a rather long time frame, from Nov. 27 to Dec. 15, and affected debit and credit cards that were used in domestic store locations. Canadian stores and the company's online business were not affected. Exposed information includes customer names, credit/debit card numbers, expiration dates, and card-verification-value, or CVV numbers.

Most estimates indicate the data breach at Target has affected some 40 million credit/debit card numbers at the point of sale, making it one of the most extensive data heists ever. 

In response to the attack, JP Morgan Chase has imposed precautionary limits to more than 2 million debit cards, which is approximately 10% of all Chase debit card accounts.

However, possibly the most damaging piece of news to come out of this is Target's slow reaction time to the attack. Target began investigating the incident almost a full week before it officially announced the hack, which may have delayed consumers' ability to monitor their accounts for fraudulent activity.

A breach of trust
The main concern for Target has to be a potential loss of consumer confidence in the retailer's brand, more so than the number of lawsuits and investigations that have already started to pop up in recent days.

The situation is especially dangerous because Target is a major player in the cutthroat business of big-box retail. If consumers feel that Target is not a safe enough place to shop at in the foreseeable future, regardless of whether it's actually true or not, the company stands to lose business.

The reality is that Target is probably the safest place to shop in the wake of the disaster considering the amount of heightened security at the retailer. However, it is all about consumer perception, and right now that is working against Target.

Management realizes the danger in this and it has already announced a 10% store-wide discount for the weekend prior to Christmas. Additionally, Target is going to offer a free credit-monitoring service to customers whose information may have been compromised.

Who stands to benefit?
Even without the recent security disaster, Target has struggled to perform well this year. This is despite the fact that Bloomberg reported earlier in the year large rival Wal-Mart was perhaps getting too big to properly focus on consumers, as many of the company's stores remained understaffed and cluttered.

Smaller companies like Target and Costco were supposedly picking up some of Wal-Mart's business, as they could remain dedicated to consumers through a smaller and more direct focus. However, only Costco seems to have capitalized.

The following is a breakdown of Target's projected growth for 2013 and 2014 compared to that of Costco and Wal-Mart:

*Costco's fiscal year ends in August

Target has struggled mightily for much of 2013. The company is expected to barely grow revenue and is the clear laggard in terms of earnings-per-share growth, as it is expected to experience a 17.6% decline in yearly EPS.

Costco seems to indeed be benefiting from its ability to engage customers more directly and appears poised to end the year with solid revenue and EPS growth. However, Wal-Mart is still growing well considering it is currently the largest retailer in the world.

In a year in which Target has struggled to grow at all, a massive security breach and loss of consumer confidence is an unfortunate and untimely event. It stands to reason that both Costco and Wal-Mart, which were already outperforming Target in 2013, will benefit from the company's recent stumble in the short term, especially during the busy holiday-shopping season.

Is there opportunity?
Savvy investors will always look for opportunity amid a major bad news event. The plunge in Target's share price has knocked the company's valuation down to Wal-Mart's level; both companies' forward P/E ratios are now 13.5. 

However, Target is not projected to grow much better than Wal-Mart in 2014 and therefore does not deserve much of a premium. Additionally, the two companies' dividend yields are relatively comparable. On the other hand, Costco has the best growth and is priced accordingly, with a forward P/E of 21.8. 

In conclusion, while Target's woes have made the company a cheaper investment, the company looks set to remain a step behind competitors like Costco and Wal-Mart.