Times are certainly tough for discount retail juggernaut Target (TGT 0.50%), as the costs continue to rise over the company's December data breach, roughly $35 million and counting. Target is also dealing with a shareholder base that seems unhappy with the company's generous compensation policies as well as with the growing losses in its Canadian operation, where the company is trying to match the success of competitors like Wal-Mart Stores (WMT +0.37%) and Costco Wholesale (COST 0.33%).
Under the circumstances, it is not too surprising that Target's board of directors made the easy decision to "sack" CEO Gregg Steinhapel in early May, though it was careful not to blame him for any of Target's current shortcomings. The question for investors, though, is whether a new CEO can help the company find its growth stride again.
What's the value proposition?
Target has never been the cheapest place to shop, but the company built a loyal customer base by operating bright, clean stores that were staffed by generally friendly and helpful staff. Target also found success with fashionable, yet affordable, branded clothing lines that were exclusively sold at its stores, like C9 by Champion and Genuine Kids by OshKosh. The net result for Target was a growing base of customers coming through its doors to which it could sell a broadening assortment of products, with a focus on the essentials category, encompassing personal care, pharmacy, and beauty items.
Unfortunately, Target's data breach has undoubtedly led to some customer defections, a trend corroborated by management and evidenced by a decline in comparable-store sales during its last two fiscal quarters. More importantly, lower customer volumes have led to a greater need to engage in promotional selling tactics, negatively impacting Target's merchandise margin.
Consequently, the company's adjusted operating profitability has been stuck in a downward trajectory, declining by a double-digit percentage in each of the last two fiscal quarters versus the prior-year periods; this hurt its ability to fund capital expenditures and engage in shareholder-friendly actions, like share repurchases and dividend increases.
Looking into the crystal ball
With Target's administration costs rising, due partially to higher technology spending in the wake of its data vulnerabilities, and with its gross margin shrinking, it is hard to see how the company is going to get back on the path to profit growth any time soon. Target's push into international markets, via Canada, was supposed to be a big part of its growth story, but making money in that geography has proven to be harder than it first appeared.
That being said, Target should probably stay the course with its international aspirations, as its competitors have shown that it is possible to make money outside of the U.S. when the right support infrastructure is in place. Costco, for one, has built a sizable presence in Canada over the years, with the geography currently accounting for roughly 13% of its overall store base and 15% of its total sales. More notably, the company's successful experience and profitability in Canada likely laid the groundwork for it to expand its franchise in other international geographies, like the U.K. and Mexico.
Likewise, Wal-Mart has found a solid amount of success in international markets, with current operations in 27 countries, including Canada, which together account for approximately 29% of its total sales. The company doesn't always succeed in specific geographies, evidenced by individual store closures in Brazil and China in its latest fiscal year; but the international segment is a key source of profit for the company, albeit at a lower margin than that generated by its traditional store operations in the U.S. The segment is also a focus area for the future, with management planning to increase its store base in a wide swath of international hotspots over the next few years.
The bottom line
Target is certainly going through a rough patch. Rising costs are eating into its bottom line, a trend that led management to recently reduce its expectations for profitability during the current fiscal year. While the company will likely figure out its problems eventually, including a path to prosperity in international markets, overall profit growth will probably take time and investors should avoid the story.
