As consumer spending remains sluggish in this weak job environment, retailers have taken a more aggressive stance to compete for consumers’ limited discretionary dollars. Specifically, retailers have stepped up on promotional activities, lowered product pricing, introduced new products, and implemented various incentive programs. However, only a handful of these retailers have positioned themselves strategically enough to benefit from an economic recovery, and this includes our newly crowned “King of Retail”: Target Corp. Target is a big-box discount retailer that operates stores offering general merchandise and food items. In addition to its retail segment, it also operates a credit card segment, which offers credit to qualified customers through its branded credit cards.
During the recession, Target’s sales were negatively impacted as shoppers traded down to lower-end stores such as Wal-Mart, which led to two straight years of comparable store sales declines: -2.9% in 2008, and -2.5% in 2009. However, the trend is reversing itself now as we emerge from the Great Recession. Target just reported its fourth consecutive quarter of positive sales comps (1.6% in Q310), driven by stronger traffic across all its stores. Target’s results were in stark contrast with its archrival Wal-Mart, which posted its sixth straight quarter of negative sales comps. Although the macro environment remains weak, consumers are clearly more optimistic about their job prospects and the near-term outlook; therefore, they are willing to trade back up to higher-end stores, like Target.
Going forward, we believe Target will continue to be a threat to other big-box discount retailers and department stores for the following reasons:
• Traffic driving initiatives: The Company is in the process of remodeling their stores and adding a fresh food section dubbed P-Fresh. This shift in capital spending from new unit openings to store remodelings is proving prudent thus far, as store traffic has improved for five straight quarters and sales in remodeled stores have generally exceeded expectations. Although the lower-margin grocery items will pressure profitability, the company said that improved sales leverage and improvement in other higher-margin categories such as apparels will likely offset those pressures. Under the remodel program, Target has remodeled 462 stores, including 341 stores remodeled year to date. It plans to remodel 380 stores in 2011, and we believe Target will continue to drive strong traffic as it improves its store displays and product assortments.
• Closing the price gap: Target rolled out its reward program in October, offering its credit and debit card customers a 5% discount for all purchases. Since the national roll out, results have met management’s expectations as issuance and usage of the credit and debit cards has increased sharply. Specifically, the 5% program is expected to add about one percentage point to same-store sales in Q4, and between 1% and 2% to same-store sales for 2011. While the general perception is that Target’s products are priced higher than Wal-Mart, management believes Target has come very close to matching Wal-Mart’s price and eliminating that price perception. With the 5% program, Target is a step closer to reducing the price gap, or perhaps, beating Wal-Mart’s prices in certain product categories. In addition to generating incremental sales, the program helps Target identify and analyze its customer demographics, therefore enabling more effective marketing to its customer groups.
• Long-term growth opportunities: Target is considering tapping international markets for growth opportunities, and might open stores in Canada, Mexico and Latin America in the next three to five years. The potential for international expansion bodes well for Target’s long-term growth. In addition, in a move similar to that of its closest rival Wal-Mart, Target plans to penetrate the urban markets in the U.S. by introducing a smaller store format of 60,000 to 100,000 square feet, versus its regular format of 125,000 square feet.
From an Economic Margin perspective (what a company earns above its true cost of capital), Target is a strong wealth creator, as it has consistently grown its profitable business. Looking at the chart below, Target has generated 14 straight years of positive EMs, while at the same time growing its store count.
If you are not subscribed to our free weekly newsletter and would like to have access to our special retail sector report, Click here, to start receiving Investment Advisor Ideas.
While TGT is one the few well-managed companies that consistently create wealth for its shareholders, not all good companies make good investments. It is very important to be aware of what embedded expectations you are paying for, which is why we will now focus on TGT’s intrinsic value. The intrinsic value chart below illustrates that TGT is currently trading at a discount to its default intrinsic value, meaning the company is currently undervalued.
There are quite a few compelling reasons to own TGT right now, and it will be interesting to see how the company fares in the battle for customers this holiday shopping season. We believe TGT is a well-run, attractively priced company that has been doing all of the right things to continue improving its business, regardless of the economic outlook. It has been very successful at getting shoppers to trade up to TGT products during stretches of economic improvement and has also proven to be successful at gaining new higher-end shoppers that trade down to TGT products during economic downswings. We expect the “King of Retail” to do well during this holiday season, and will be closely monitoring the entire retail sector over the coming month.
With Black Friday kicking off this morning we have focused our attention on retail stocks we find attractive. If you are a subscriber to our weekly newsletter, you can access our top 10 retail picks within the S&P 500, as well as get an understanding of the embedded expectations in the retail sector.
If you like this article, you must read: Growth vs. Value