How Does Target Differ from its Peers

Edgar 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) recently reported its second quarter EPS of $1.06, which beat the Street's consensus of $1.04.  Its $704 million net income stems from its new store openings and robust same store sales growth that the company has been able to sustain. But what does Target do that appeals to the average consumer? How does it differ from the rest?

It seems to me that the company seeks to appeal to customers that are interested in sophisticated styles and quality; by offering trusted unique brands and exclusive designer labels such as Maternity by Liz Lange and others.  It tailors its product offerings and ensures that its guests can find exactly what they need at any state, whether its Goya black beans in Miami or an extended assortment of winter coats in Minnesota.  There are several distinct attributes that distinguish the simplicity of the company's mission.

5 Reasons Target Shines From its Competitors

  • Product assortment differentiation - trusted national quality owned brands with exclusive offerings, including some of its design collaborations with Missoni and Calypso St. Barth, in addition to celebrity partnerships with Shaun White and Gwen Stefani.
  • Aggressive store remodeling program - which if combined with its new store openings, brought food assortments and merchandising reinventions to more than 400 stores in 2011.
  • Continuous growth in untapped markets - investment in new CityTarget stores and expansion plans into Canada in 2013. 
  • Unmatched brand loyalty - which lead to an increased spending that was evidenced first hand by more visits of Target REDcard holders who saved an additional 5% on purchases.
  • Social Responsibility - School Library Makover initiatives in which employees helped revitalize 42 elementary school libraries across the country and simultaneously increase awareness of their brand.

"Expect More, Pay Less" / P-Fresh Layout

Under this slogan, Target satisfies customer demand for value by matching Wal-Mart's (NYSE: WMT) prices on similar items in local markets, and by pricing its differentiated products at deep discounts.  Historically, Target has drawn far less traffic from its food segment than its main competitor Wal-Mart.   To combat this setback, in 2008 Target introduced its PFresh store layout, which by far has a more deeper assortment of dry, dairy, frozen foods, baked goods and deli sections than it did a year ago.  The success was immediate as the company later saw its remodeled same store sales rise 2.1% in 2011 and 3% in the first half of 2012. 

RED Finance Cards Keep Customers Coming Back

Two years ago Target announced a new customer rewards program, which was aimed at driving incremental sales and earnings among its RED charge cards.  Its plan to reward loyal consumers by giving them a 5% discount every day a REDcard was used, was favored instantly by its loyal shoppers.  This was an attempt to maintain a competitiveness with Costco's (NASDAQ: COST) Executive Membership card, which indirectly forces the consumer to keep coming back to save more.   After all who wants to pay for a gym membership card and not use it despite not wanting to work out? Although the Executive membership helped drive the  majority of Costco's profits in 2011, its margins were negatively impacted due to the 2% reward that was associated with the first time enrollment.  As for Target, previously new RED card holders used to receive an initial 10% off coupon and existing cardholders earned coupons for 10% off a future day of shopping. This effective change allowed TGT to boost its same store sales by 2% in 2012.  

High Gross Profit Margins vs. Slower Revenue Growth

TGT Revenue Growth data by YCharts

Despite its lackluster 5 year revenue growth of 3.32% against some of its competitors like Wal-Mart, Costco and Dollar General (NYSE: DG), Target still takes the cake in locking in gross profits per item sold.  As you can see in the chart below, its five year average gross margins of 32.03%  trump Wal-Mart's 24.63% and Costco's 12.46%.  But why are the variations so large? Does Target have pricing power with its wholesalers that Wal-Mart should envy? Not likely!

As a matter of fact, the COGS levels are very similar across both companies, but the difference lies within their sales and their slogans.  Wal-Mart's "Low Prices - Every Day" means that the company takes an 8-10% discount on its sales revenue compared to Target.  Consumers expect more at Target, but do they pay less? No.  Target's "Expect More and Pay Less" phrase does exactly the opposite - charges more for its merchandise and expects its customers to pay a premium for a higher quality.  in addition to expecting a premium from its consumers, over the last five years Target was able to increase its retail square footage at a compounded annual growth rate of 4.2% in over 300 of its new stores.

TGT Gross Profit Margin data by YCharts

 

Buybacks / Dividends / Valuation

An effective way to keep shareholders committed is through share repurchases. This last quarter Target did just that, it invested $549 million to buy back 9.6 million shares of its common stock at a price of $57.09.  Target also rewarded its shareholders with its 2.25% yield of $198 million. Based on a Gordon Growth model Target should trade around $72, but observing the price bar chart over the company's historical EPS gives us a sign of warning.  Notice how Target traded near its true earnings levels and despite a few divergences, it traded at a fair multiple.  At a current price level of $64, the stock seems to have diverged from its EPS of $1.06 at a much higher standard deviation than it did before.  This could potentially signal that investors are beginning to pay a premium for its future growth prospects; or that the stock is getting way ahead of itself and a pullback is imminent. 

Conclusion

The fundamental outlook on retail general merchandisers remains to be positive despite Dollar Tree (NASDAQ: DLTR) coming in a little short of the Street's expectations due to a rising SG&A of 6.8%.  Some of the recent retailer earning misses were due to company specific problems, not attributed to sector weakness.  As pockets of inflation and lack of job stability causes consumers to keep their belts tighter, I believe that Target has a good mix of quality versus price in all of its business segments.  It is complex to draw comparisons between Target and its peers, since some of its carried goods could be found in J.C.Penney, Costco or teh frozen section of Wal-Mart.  In addition, fierce competition is driving all of these companies to try out each other's ideas and strategies, even diving into the organic food segment.  Discounters are solely benefiting from cost conscious consumers that are focused on buying every day necessity items for much lower prices.  Therefore the demand for general merchandise products carried by discounters will generally be stable in the upcoming years. I'm a long term bull on Target going into 2013, but have a neutral to bullish position for the remainder of the year. 


edgarambart30 has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.

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