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Target’s $100 Million Bet: Will It Pay Off?

By Dan Moskowitz – Mar 13, 2014 at 6:30PM

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Target’s data breach has hurt its reputation, but Target is making a significant bet to ensure that its future reputation will turn for the better.

Target (TGT 0.70%) suffered a significant blow with the data breach. Not only will it now have to contend with a myriad of expenses, but some of its customers lost trust in the brand. This was an unfortunate event, and one that likely could have been prevented.

According to The Wall Street Journal, Target didn't take the simple step of walling off its payment system from the rest of the network. If this is accurate, then it's a sign of poor judgment on Target's part. However, what's done is done, and Target can only attempt to uncover ways to fix its problems.

The big investment and relative fiscal strength
Target is investing $100 million in data security. Target's fiscal situation allows for such an investment. While the company's balance sheet leaves much to be desired: $695 million in cash and short-term equivalents versus approximately $13.8 billion in long-term debt, Target did generate an impressive $6.5 billion in operating cash flow over the past year. Therefore, Target can afford such an investment.

Target's biggest competitors are Wal-Mart Stores (WMT 1.44%) and (AMZN -2.71%). Like Target, Wal-Mart's balance sheet isn't impressive, with approximately $7.3 billion in cash and short-term equivalents versus $56.6 billion in long-term debt. However, it generated a massive $23.3 billion in operating cash flow over the past year. Therefore, if Wal-Mart were to face a data breach or similar unexpected situation, it would be capable of fixing the problem.

Amazon is the biggest threat to Target and Wal-Mart, and while Amazon isn't the size of Wal-Mart (yet), it's more fiscally impressive on a relative basis. Amazon sports a strong balance sheet, with $12.4 billion in cash and short-term equivalents versus $6.14 billion in long-term debt to accompany approximately $5.5 billion in operating cash flow generated over the past year. Amazon has been growing at a rapid rate, and that kind of growth often coincides with unexpected headwinds. Fortunately, thanks to Amazon's fiscal strength, it can likely handle these types of situations better than Target or Wal-Mart.

As far as Target's massive investment goes, it might lead to short-term pain, but it's also likely to result in long-term benefits. This capital will go toward adopting chip-enabled technology, which will be issued via Target-branded smart chip and debit cards. If Target succeeds in this area, it will be ahead of industry trends. And ironically, it will be one of the safest shopping destinations in the United States.

Target was actually one of the few retailers that first stood up for secured technology; but the industry didn't follow along and Target gave up, figuring that the costs wouldn't be worthwhile. Based on recent events, Target has understandably changed its position on the matter.

Time to invest in Target?
If you're looking far into the future, then Target could be attractive at this point in time. However, given the fact that Target still doesn't know the total cost of the data breach, this could be risky. Additionally, Target attracts a higher-end consumer than Wal-Mart, which puts it more in-line with Costco Wholesale (COST 0.45%).

Costco just missed second-quarter expectations, with earnings per share coming in at $1.05 versus the Capital IQ consensus estimate of $1.17. This "poor" performance relates to weak holiday performance, weaker margins in fresh foods, and soft international performance due to foreign exchange rates. All that said, revenue increased 5.8% year over year, with comps improving 3%.

On the other hand, perception is everything on Wall Street. If Target and Costco attract similar consumers, then investors will get nervous on Target due to Costco's recent results.

The Foolish takeaway
Due to the aforementioned reasons, this might not be the best time to establish a position in Target. However, Target is taking a wise long-term approach by making a significant investment in chip-enabled technology for improved customer data protection. This should ultimately lead to increased consumer trust. In other words, Target should see better days ahead, but it might take a while to get there. Please do your own research prior to making any investment decisions. 

Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends and Costco Wholesale. The Motley Fool owns shares of and Costco Wholesale. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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