Is There More Upside in Store for This Retailer?

Ashit is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Target (NYSE: TGT) is one of the largest economy retailers in the U.S. It competes in several categories with giants such as Wal-Mart (NYSE: WMT) and Costco (NASDAQ: COST). With approximately 1,800 stores, it offers a wide variety of apparels, household essentials, groceries, and home furnishings.

Target already has a strong presence across the U.S., and now plans to expand internationally in order to sustain its growth. Further, considering the strong growth in the online retail market, Target is also investing heavily to bolster its e-commerce channel.

Going forward, Target faces a big threat with the growing presence of warehouse clubs, such Costco and Wal-Mart's Sam's Club. Additionally, large number of stores already in U.S can lead to sales cannibalization.

Factors that will spur growth in the future

International expansion

To bolster its international presence, Target signed a lease with Zeller stores, which is Canada’s largest economy retailer. During 2011, Target increased the budget for Zeller stores and amalgamated them into its retail channel. Further, the retailer plans to launch 24 new stores on the Canadian soil and will add another 100 by the end of 2013.

Expansion in Canada has been a common feature for several U.S.-based retailers. As the U.S. market gets more and more saturated, many retailers are now relying on international expansion to sustain positive cash flows.

Its competitor Wal-Mart has massive international presence with approximately 5,500 stores globally. The retailer has been extremely successful in Latin America, and going forward, Target must replicate Wal-Mart’s success in countries such as Brazil and Mexico in order to remain competitive.

Online sales to drive the U.S. retail industry

Growing popularity of tablets and smartphones, coupled with increasing internet penetration, underpin the exponential growth in online retailing. According to Forrester, the U.S. online retail market will grow at a rate of 13% from 2013 to 2017. It is noteworthy, that total online sales have grown at an average rate of 17% during the last nine years.

Recently, Target’s management revealed that online sales grew faster than the overall industry mean. To bolster its online channel, Target has invested heavily in its e-commerce site. In addition, as part of the initiative, the company offers free WiFi in all its primary stores, in order to promote and encourage customers in purchasing through its e-commerce site.

As a part of Merchant Customer Exchange, Target is making special efforts in developing a more competent mobile commerce platform. Mobile commerce sales constituted 3% of the total online sales in U.S. during 2012, and going forward, they are expected to reach 9% in the next five years.

Potential threats that may offset the positives

Increasing probability of sales cannibalization

Target has a huge presence across the U.S. with approximately 1,800 stores. Hence, the retailer faces a constant threat of sales cannibalization. The like for like sales for its stores during 2010 grew 2.1%, which is a minor increase considering sales in 2008 and 2009 suffered due to economic instability in the U.S.

The growth in like for like sales picked up slightly in the following years. However, Target itself acknowledges that cannibalization is the primary cause behind the sluggish like for like growth in store sales.

Going forward, Target should not be over aggressive with its expansion plan, as opening numerous stores will lead to a fall in average footfall, which will result in Target not reporting any organic growth.

Economic instability and increasing competition

Nearly 80% of Target’s revenue is generated through sales of apparels, home furnishings, groceries, and other consumer goods. A slowdown in economic growth and below par consumer spending will be a huge hindrance for Target. With rising unemployment, consumers are cutting down on expenses and finding new methods to save money.

This is a huge cause for concern, as several customers are now turning to warehouse clubs such as Costco and Wal-Mart’s Sam’s Club for higher discounts.

Costco is much larger than Target in terms of annual revenue. During 2011, Costco reported annual revenue and gross profit of $92 billion and $11 billion, respectively. It operates 429 warehouse clubs in U.S. and 163 internationally. Sales from warehouse clubs account for approximately 80% of total revenue.

Costco is already present across the U.K. and Canada, and going forward, it has a balanced expansion plan lined up for Asia. Costco has a unique business model, as it offers massive discounts to buyers purchasing in bulk quantities. This allows Costco to outdo economy retailers such as Target in an unstable economic environment, where consumers are looking to save every penny.

Similar to Costco, Wal-Mart’s Sam’s Club also offers huge discounts to its members. Sam’s Club leverages Wal-Mart’s enormous bargaining power with suppliers, which enables it to sell at cheaper rates compared to any economy retailer. Although the business operates on low margins, it predominantly gains through volumes.

Neutral rating

Target’s current share price seems to be trading at a fair value. Given the trends and the industry outlook for U.S. retailers, the intrinsic value of the stock appears to be at par with the market value.

As illustrated earlier, growth opportunities through international expansion and the e-commerce channel, and threats such as increasing competition and sales cannibalization lead me to believe that Target is a Hold, at least for now.

Ashit Gulati 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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