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Why Target Is Throwing in the Towel on Canada

By Rich Duprey - Jan 15, 2015 at 2:57PM

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Things haven't been going the retailers way in the Great White North and cutting its losses is its best option

Target's been checked at the border since opening its first store in Canada in 2013.

Canada has given Target (NYSE: TGT) nothing but a chilly reception since it opened its first stores there. Between 2011, when it bought Hudson's Bay's Zeller's chain, and the third quarter of 2014, Target lost over $2 billion on its Canadian operations.

Which of course is why this morning's announcement that it was giving up on the Great White North by discontinuing all operations in the country, really isn't all that shocking. After all, it was best to cut ones losses before they mount any higher. 

A losing proposition
Despite all the fanfare that accompanied Target's entrance into Canada and the optimism it could achieve $6 billion in sales within a few years, it was never able to gain traction because Wal-Mart (WMT 0.99%), Costco (COST -1.12%), and large, local food retailer Loblaw's  were all seen as providing consumers with a better value proposition. Target was routinely criticized for offering higher priced goods than its rivals and failing to stock enough product on its shelves. Even over the Christmas holidays analysts said customers still couldn't find products in stock.

Wide open spaces
That was the real startling difference. Here at home Target was and is recognized as a top retailer that works hard to develop and maintain customer loyalty as well as running smart logistics operations. Unfortunately, in Canada it's been a different story.

Although there are a lot of similarities between the two countries and their cultures, the U.S. has over 300 million people occupying 3.8 million square miles, or a little more than 80 people per square mile. Canada, though, is largely a sprawling wilderness with just 35.5 million people spread across the same sized land mass. That works out to about nine people per square mile, meaning it's much more expensive to service customers up north than in the U.S.   

Sales stuck in reverse
And sales never materialized. While third quarter Canadian sales hit a record $479 million record, up 43% from the year-ago period, operating losses were still $211 million, only slightly narrower than the $238 million it lost the year before. Although comparable sales were up 1.6% in the quarter, the gains were largely the result of sales made at "non-mature stores," or those not opened long enough to be included in the comps numbers.

As a result, it's estimated Target's sales per square foot of $140 were almost half of what they should be just to break-even. Analyst Scott Mushkin of Wolfe Research says the retailer would have had to grow comparable store sales 21% annually each year for the next three years to reach that level.

No doubt Target's management realized the impossibility of the task and decided it was better to retreat than fight the tide against it.

Taking the dogsled south
Exiting won't be cheap though. Target Canada operates 133 stores across the country and employs approximately 17,600 people. The leases the retailer bought from Hudson's Bay alone cost it $1.8 billion and Target has built three distribution centers since first moving in.

In its release announcing its exit from Canada, Target said it would be making a voluntary contribution of $59 million into a trust for employees that will give virtually all of them 16 weeks of compensation. It will also be providing $175 million in debtor-in-possession financing to its Canadian operations allowing them to continuing functioning with minimal disturbance.

Target will be taking the largest portion of the write down of its business in its fiscal fourth quarter, or $5.4 billion worth in pre-tax losses. Expect the big wash to severely impact the retailer's overall results. Over the course of its 2015 fiscal year, it will incur an additional $275 million of pre-tax losses, but the cash costs are expected to be between $500 million to $600 million.

The silver lining to the gray clouds
On the bright side, because Canada was such a drain on its performance, it expects the decision to increase its earnings in fiscal 2015 and beyond, while increasing its cash flow in fiscal 2016 and beyond.

There might be a lesson Sears Holdings (SHLDQ)might be able take away from this debacle. Sears has been trying to unload its Canadian operations, but the business is apparently so damaged no one was willing to pay the asking price and CEO Eddie Lampert was forced to start loaning money to the retailer to get it through the holidays. Perhaps instead of always trying to find some angle, he should just make a clean break as Target is with its Canadian operations. 

In short, it's not as easy to run a retail operation in Canada as it is in the U.S. For Target, which was suffering from extended losses in Canada, those were simply higher costs than it could continue justify paying. Circling the wagons and playing to its strengths here at home is undoubtedly the best decision for investors.

Follow Rich Duprey's coverage of all the retailing industry's most important news and developments. He has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. 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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Stocks Mentioned

Wal-Mart Stores, Inc. Stock Quote
Wal-Mart Stores, Inc.
$128.87 (0.99%) $1.26
Target Corporation Stock Quote
Target Corporation
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Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
$535.82 (-1.12%) $-6.08
Sears Holdings Corporation Stock Quote
Sears Holdings Corporation
Hudson's Bay Company Stock Quote
Hudson's Bay Company

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