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Target Is Entering Canada! Is the Stock a Buy?

March 03, 2013 | About:
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Gordon Pape

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Target's long-awaited and much-ballyhooed entry into Canada is finally happening. The giant U.S. retailer will open its first stores in selected markets this month in advance of an Ontario roll-out starting in April. Over the spring and summer, more stores will open in Western Canada with the Quebec stores scheduled for the fall. By year-end, the company will have a total of 124 stores in operation. Target's arrival was kicked off by a 60-second television spot that aired during last week's Academy Awards. It was specially designed to tug at our heartstrings, using the theme song from the old children's show Mr. Rogers Neighbourhood against a montage of iconic Canadian scenes. The ad also featured Bullseye, the company's mascot bull terrier. Get ready to see a lot more of the mutt in TV commercials and on billboards in the months to come.

As Target (TGT) gears up to battle for a share of the Canadian retail market, competitors are preparing to protect their turf. For example, Walmart (WMT), which is already well-established here with 379 stores, has announced it will spend $450 million to expand its Canadian operations this year.

Sears Canada (TSX:SCC), which is widely believed to be the most vulnerable, is already feeling the pain, even before the first Target store has opened. Sears reported that same-store sales were down 5.6% in 2012. That's a steep decline and it's likely to get worse as consumers discover Target.

That's because they're going to like what they see. Having shopped at Target several times in the U.S., I can report that the stores offer good prices and high-quality merchandise from electronics to clothing, including many exclusive fashion lines. In this country, that will include specially designed clothing from one of our iconic garment makers, Roots.

Target stores are also much more visually appealing than their often drab Walmart and Canadian Tire competition. I predict it won't be long before Target becomes a hot topic of discussion and a favourite destination for many shoppers.

So if the stores are likely to be a big hit, why not buy the stock? Good question. Let's take a look at it.

We'll start with the big Canadian news from last week's release of the company's fourth-quarter and year-end 2012 results. The company revealed that its expansion into Canada is costing a lot more than expected. Management originally expected to spend between $10 and $11 million per store, or about $1.3 billion in total. Now the cost is being pegged at $1.5 billion which the company says will translate into a reduction to 2013 projected earnings per share (EPS) of about $0.45. As a result, Target is forecasting adjusted EPS for this year of between $4.85 and $5.05 a share (figures in U.S. currency).

For 2012, adjusted EPS was $4.76 a share, which included a $0.48 charge for the Canadian expansion. That means that projected growth this year will be between 1.9% and 6.1%. At the low end, that's negligible. At the high end, it's a big step down from a 7.9% gain in EPS in 2012.

But the company expects to start getting some payback on its big foreign expansion - the first it has ever undertaken - by the fourth quarter. By 2014, the Canadian operations should be making a significant contribution to the bottom line but at this point no one is predicting how much that might be.

Small wonder! Although Target is very popular in the U.S., no one can say with any certainty how Canadians will react. One thing is certain: there will be a lot of media focus on price comparisons during the early days. Journalists and consumers will looking at how much the same item costs in Canada and the U.S. and how Target's prices compare with its Canadian rivals. If Target comes off badly out of the gate it will put a damper on the launch and slow customer acceptance.

This uncertainty makes the stock a little more risky than it would otherwise be. But it also offers significant upside potential to earnings per share in 2014 if all goes well.

In announcing its 2012 results, Target said its full-year sales increased 5.1% to $72 billion from $68.5 billion in 2011. This reflected a 2.7% increase in comparable-store sales combined with the contribution from new stores and one additional accounting week

As things stand right now, the stock has a trailing p/e ratio of 14.2 and a forward ratio of 11.4. By comparison, Walmart's trailing p/e is 14.3 while the forward p/e is 12.2. So Target shares are a little cheaper by comparison. According to data compiled by Thomson/First Call, analysts are slightly weighted towards the buy side on their calls with a median target of $71.50 a share.

The stock pays a quarterly dividend of $0.36 a share ($1.44 a year) to yield 2.25% based on Friday's closing price of $64.13. Also, Target has an active share buy-back program. In 2012, the company spent $1.9 billion to repurchase 32.2 million shares at an average price of $58.96. That represented 4.8% of the shares outstanding at the start of the year.

Action now: Target becomes a Buy for patient investors who believe the company's entry into Canada will pay off in 2014 and beyond. The shares trade on the New York Stock Exchange under the symbol TGT. My initial target price is $70 which, if achieved, would give us a total return of 11.4% in the first year, including dividends.

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

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