For Target (TGT +1.06%) shareholders, the last six months have been rough. With the shares down by more than 10%, it's a good time to reevaluate why you own the stock. Today there are three issues that Target needs address to get earnings moving in the right direction. If the company can right the ship, the drop in the the stock could represent an attractive buying opportunity for long-term investors.
Canadian expansion proving to be tough
It's all too easy to assume that Target is suffering because companies like Amazon.com (AMZN +0.53%) and Wal-Mart Stores (WMT 0.52%) are eating its lunch. If you had a nickel for every time Amazon was touted as "disrupting" an industry, you would be retired and lying on a beach instead of reading this article.
Wal-Mart has been a fierce competitor for years, and in many towns a Target and Wal-Mart are just a few miles apart. So it makes sense that Target is having trouble keeping up with its rivals.
However, most of Target's problems today have more to do with the company's expansion into Canada. In the last several quarters, Target has taken multiple earnings hits because of Canadian expansion costs.
Let's get the obvious out of the way first
The first way Target can hit the bull's-eye in the future is by carefully managing expenses in its Canadian operations. The company is on its way to 125 stores in Canada, but is spending more than 66% of revenue on selling, general, and administrative expenses.
As Target's Canadian operations improve, this SG&A percentage should be cut significantly. By comparison, Amazon spends about 28% on SG&A, Wal-Mart spends 19%, and Target's domestic operations clock in at 21%. With $0.29 of lost earnings in the current quarter alone, you can see there would be a significant change in earnings per share if the Canadian division just broke even.
Shifting focus
Though a recent data breach is hurting the company's brand today, consumers thankfully have a very short memory. With Target offering credit monitoring and credit card companies issuing new cards to eliminate potential issues, this problem will likely fade over the next few months.
Wal-Mart gets roughly 55% of its sales from lower-margin grocery sales, which accounts for the company's 25% gross margin. Amazon gets more than 65% of domestic sales from electronics and general merchandise. In this extremely price-sensitive market, Amazon carries a respectable gross margin of nearly 28%.
Target, on the other hand, sports a gross margin north of 30%, and this is largely due to the company's focus on clothing and home goods. Target regularly signs exclusive deals with designers that aren't normally found in "discount" retailers. A recent example is Target's deal with Peter Pilotto to bring a small portion of this London-based label to the Target chain.
Whether it's exclusive Merona clothing for women, Cherokee for kids, Circo, or Threshold, Target knows that well-defined brands are what drives better margins.
The more customers see RED, the more Target sees green
The third reason Target can hit the bull's-eye in the future has to do with the company's REDcard. While a lot has been made of Amazon's Prime membership benefits, the inescapable fact is customers must pay $79 a year.
Wal-Mart and Target both offer free site-to-store shipping. However, Target offers free shipping for online orders with the REDcard, whereas to get free shipping with Wal-Mart you must spend $50 or more.
The Target REDcard also offers a 5% discount on all purchases. With 5% off in store and online, customers get a discount that neither Wal-Mart or Amazon can match. With Pharmacy Rewards, for every five prescriptions filled, the customer gets an additional 5% shopping pass for a day of shopping.
With domestic REDcard penetration increasing from 8% to 9.5% on the credit card side, and from 6% to 10.4% on the debit card side, Target is making excellent progress. Clearly customers see the benefit of having a little more RED in their wallet.
Final thoughts
In today's market, waiting for a company to get its first international expansion working right is a challenge. Long-term investors should realize that Target didn't grow to more than 1,700 stores in the U.S. overnight, and the company's Canadian expansion is ambitious and initially costly. However, as the company gets its Canadian operations on firmer footing, this division will stop being an earnings drag and will start to contribute to the bottom line.
With Target's focus on clothing and home goods, the company should continue to carry a higher gross margin than some of its well-known peers. In addition, the more penetration the Target REDcard gains, the more incentive shoppers have to come back to Target for all their shopping and pharmacy needs.
The bottom line is, Target's recent stock price swoon could be an opportunity for long-term investors. With the stock now yielding nearly 3%, and with analysts still calling for 11% EPS growth, this is a long-term value worth a second look.
