Target (TGT, Financial), the second-largest big box retailer in the U.S. with more than $70 billion in annual revenue, has found the going a little rough due to the fast-changing retail scenario.
Target displayed strong growth during the 2007-2013 period despite the great recession only to see its fortunes slip away since then. There were plenty of mistakes on the company’s part that restricted its  growth, but the real question is: Where does Target go from here?
Ecommerce has completely upended the retail industry in the U.S. Amazon’s (AMZN, Financial) near $100 billion annual revenue was practically snatched away from traditional retailers. The online retail giant’s sales have grown tenfold in 10 years, and nothing is going to stop it from repeating that success in the next 10 years. Obviously, Amazon is not creating a new market; it is merely taking away market share from existing stakeholders such as Target, Walmart (WMT, Financial), Costco (COST, Financial) and all other retailers.
It is indeed a difficult environment for big box retailers, especially the ones that are not able to clearly articulate their differentiators to their U.S. retail buyers. Target is growing through just such an identity crisis, and the company needs to make sure that it stands out from its peers.
Too dependent on the U.S. market
Unfortunately for the company, Target’s international ambitions never took off, and it is still overly dependent on a single country for the bulk of its revenue. The Canadian foray was a huge mess because the company expanded too quickly, and as a result kept losing so much money that it finally decided to pack its bags and come back home far too soon. The U.S. market is indeed a huge one, but there is enough competition to make retailers bite their nails. Compared to other retailers, this severely limits Target’s opportunities and leaves it without any margin of safety.
"Target Corp. will exit the Canadian market after less than two years in a surprise retreat that will throw more than 17,000 employees out of work and trigger a $5.4 billion quarterly loss." –Reuters, January 2015
Every retailer in the U.S. is looking to add more stores, and all the while there is Amazon waiting in the wings to steal away one customer at a time. In a highly developed and highly saturated market, growth will be extremely difficult to come by. There are thousands of big box stores spread around the U.S. so it’s down to a question of how many more stores they will be able to add and for how long.
As a result, companies that do not have international exposure will have a hard time competing on an even scale with companies that have a robust international presence.
Target’s online operations are yet to take off
It is clear that the company is dependent on the U.S. market, which is gradually shifting toward an online model. Though ecommerce is never going to make big box stores extinct, it is going to play a major role in the way retail business will be conducted in the future. Big retailers who are able to leverage the advantage of their store footprints with a strong online presence will be the only ones capable of challenging Amazon.
Walmart is already traveling at a rapid pace down that road, trying to build an ecommerce-to-Neighborhood-Market-to-Supercenter network, each capitalizing on another’s strengths to ultimately serve customers more efficiently. It’s a great strategy, and if it can execute it well it could become a huge differentiator for the company.
Target is still way off in its online game. Last year, digital operations accounted for a mere 3.4% of sales. Though it has improved in the last three years, the push is slow for a company that needs to hold its ground in the domestic market.
Target’s response to the problem
The good news for Target investors is that the company seems to be well aware of the problem and is working toward differentiating itself from the rest of the crowded market. Execution has been the Achilles' heel for the company, and a lot will rely on how quickly it is able to execute its plans.
Excerpts from 2015 annual report:
"The continuing migration and evolution of retailing to online and mobile channels has increased our challenges in differentiating ourselves from other retailers.
"In particular, consumers are able to quickly and conveniently comparison shop and determine real-time product availability using digital tools, which can lead to decisions based solely on price, the functionality of the digital tools or a combination of those and other factors.
"We must compete by offering a consistent and convenient shopping experience for our guests regardless of the ultimate sales channel; providing and maintaining digital tools for our guests and team members that have the right features and are reliable and easy to use; working with our vendors to offer unique and distinctive merchandise, offering certain services our guests desire in our stores through third parties, such as CVS (CVS, Financial), offering a compelling guest loyalty program and encouraging our guests to shop with confidence with our price-match policy."
There’s no doubt that Target has a lot of problems on its plate, and it needs to act fast or lose customers to the competition. The company is trading at a low forward earnings multiple of 12.7, but even at this price point it is difficult to recommend the company. I would rather watch its plans unfold and join the bandwagon at a later point.
Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.
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