Since it opened its first Canadian store in 2013, discount retailer Target Corporation (NYSE:TGT) tried very hard to build a successful business there. At the time, expansion into our northern neighbor made sense. Target was previously confined entirely to the United States, where the discount retail space is fiercely competitive, and Canada was already fertile territory for big-box retail. And Target's competitor Wal-Mart Stores (NYSE:WMT) had established WalMart Canada in 1994 and had grown to operating 391 retail units there, suggesting a precedent for success.
Unfortunately, Target Canada didn't catch on with consumers. Initially, Target Canada racked up impressive sales growth, but this was largely because of deep discounting that resulted in massive losses. In my last review of Target, I suggested it would be better to shut Target Canada down and refocus on the United States.
On January 15, Target did exactly that. Here's why Target's strategic shift is the right move, and what's in store for investors going forward.
Missing the Target
Target announced it will close all 133 Canadian stores. This is a difficult decision in the near term, because Target will incur $5.4 billion in pre-tax losses in the fourth quarter from costs associated with the exit as well as sizable impairments.
Initially, Target Canada was able to bring shoppers through the door because of the significant promotional activity associated with the stores' grand openings. Whereas Target Canada racked up $1.3 billion in sales in the past three quarters, which was 90% growth from the same period the year before, Target Canada lost $627 million in the same period in earnings before interest and taxes.
And, once the promotional activity ended, shoppers in Canada didn't return. This dynamic was evident in poor same-store sales numbers -- the metric that analyzes a retailer's sales from stores that are at least one year old. Over the past three quarters, Target Canada's same-store sales declined 3.3% year over year. Equally concerning is that profitability wasn't likely to happen any time soon. Target Canada would not have been profitable until 2021, at the earliest.
The takeaway for investors is that sometimes, it's wise to cut your losses when a once-promising strategy isn't working. It made little sense to continue investing aggressively and booking huge losses for such a long time. Now that investors can finally close the book on the Canada experiment, here's what should be in focus moving forward.
Back to basics
Target's future core initiatives will refocus on U.S. growth. Without the Canadian stores utilizing resources, Target is free to invest more in the U.S. market, where growth is much more promising. This will be accomplished through two core strategies, which are growth in a new store format, as well as through new channels.
First, Target is in the early stages of building out its Target Express and City Target small-store concepts to boost sales in urban areas and big cities, which big-box retail has not yet fully penetrated.
This is a smart strategy, since the small-store format has been a success for WalMart. (Its smaller Neighborhood stores posted 5.5% same-store growth last quarter, which was well above its overall 0.5% comparable growth in the United States.) For discount retail, inner-city shoppers are a major opportunity, and since Target only operates eight Target City stores and one Target Express store right now, there is certainly room for growth.
In addition, digital sales, fueled by mobile, can bring Target growth. Online sales jumped 30% last quarter, and mobile traffic soared 50%, which represented significant acceleration from the previous quarter. Conversion was solid as well, as digital growth contributed 60 basis points to Target's U.S. comps last quarter. This success likely continued in the fourth quarter. Target announced a number of initiatives to drive further gains in mobile, like free shipping on all online orders during the holiday season, as well as in-store pickups at all U.S. stores.
Target is back on track
While the decision to leave Canada will result in significant near-term costs, it was the right call. The plan simply didn't work as intended, and it left Target with huge losses and diverted valuable resources away from its more important initiatives such as mobile growth and building up the small-store format. Plus, Target anticipates the closure of its Canadian stores will increase earnings as soon as this year. The key takeaway for investors is that management made the necessary decision to right the ship, and Target is back on track.