Will Red Card and Canadian Expansion Help This Retailer Hit the Bulls-eye?

Ash 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) entered Canada in the first quarter this year and its initial results are motivating enough for it to move ahead with stores growth plans in the country. Its entry strategy, with its Red Card penetration already there in the Canadian market, helped it to achieve 38% gross margin. In addition to international expansion, it has also taken initiatives for acquisitions and partnerships to improve its Omni Channel network including online and mobile sales. Its collaboration with Facebook, Google and eBay will help it to increase its customer base. Now let’s discuss these initiatives in detail.

Target Canada and City Target stores will drive sales growth

In the first quarter this year, after two years of preparation and customer engagement in Canada, Target entered into this market with 24 stores which were opened this quarter. The company has plans to open 20 more stores in the second quarter and 120 stores by the end of 2013. City Target are small format stores located in urban centers which are focused on the younger and more active customer base. These stores keep smaller number of SKUs mainly used by the young generation such as sports merchandise, frozen food and apparel. At present, only 6 such stores are open in the US, but these stores have generated strong sales, including over the holiday season.

Red Card and PFresh will continue to benefit the company

Red Card penetration is one of the reasons behind the successful entry of Target in Canada. Red Card penetration in Canada is very high with around 30,000 accounts already open, even before the company’s entry; this increased to 44,000 after opening. In the US, card penetration is expected to increase 15-20% by the fiscal end. New card holders are spending 50% to 150% more than the typical customer, with 8-10 more visits per year. Pfresh also continued to lift sales in grocery and household categories with the last three years average of 10% increase in sales.

Omni channel, Mobile and Online initiatives will drive long term growth

In the 1st quarter, Target announced the acquisition of two online channels: Chef’s Catalog, and cooking.com. This acquisition is expected to drive online and mobile sales growth in the long term. Its mobile traffic has grown at three digits pace in the 1st quarter which is catering to 30% of the sales. It has launched Cartwheel with collaboration of Facebook, which provides savings with combo deals. In selected markets it has launched same-day delivery in partnership with Google and eBay. All these initiatives will drive growth in FY 2013.

 Peer Analysis

In discount retail space, other two companies which are close competitors of Target are Wal-Mart (NYSE: WMT) and Costco (NASDAQ: COST). Walmart is already present in the Canadian market from long and it is focusing on Supercenter format. It is converting its discount stores into Supercenters and opening 40 new Supercenter sites in Canada. In the US, it is opening 100 new small format Express stores and Neighborhood stores by the end of this fiscal. These stores are 10% in size of the standard Supercenter with 15,000 items. They are less costly in maintenance and with less space occupancy. These initiatives will propel its growth going forward.

Costco is going strong this year, with new store openings and increased membership renewal rate. They are targeting 28 new stores this year which is significantly more than the 16 openings in FY 2012. Its membership renewal was 89.9% in the US and 86.4% worldwide in the 1st half of this fiscal year despite the membership fee increase to $55. Its membership fee income grew 14.7% in this period and is expected to continue as a good source of cash flow. 

<table> <thead> <tr><th> <p><strong>Company </strong></p> </th><th> <p><strong>P/S ratio</strong></p> </th><th> <p><strong>Op. Margin</strong></p> </th><th> <p><strong>1 yr. Fwd. P/E</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>Target</strong></p> </td> <td> <p>0.67</p> </td> <td> <p>8.43%</p> </td> <td> <p>12.82</p> </td> </tr> <tr> <td> <p><strong>Walmart</strong></p> </td> <td> <p>0.54</p> </td> <td> <p>5.65%</p> </td> <td> <p>12.98</p> </td> </tr> <tr> <td> <p><strong>Costco</strong></p> </td> <td> <p>0.44</p> </td> <td> <p>2.97%</p> </td> <td> <p>21.76</p> </td> </tr> </tbody> </table>

Source: Google Finance and Yahoo Finance

Target is the best performer among the three above mentioned peers with highest operating margin of 8.43% and lowest forward P/E of 12.82. Walmart has decent operating margin of 5.65% but relatively low forward P/E of 12.98. Costco is the least preferred choice among the three with lowest operating margin of 2.97% and highest forward P/E of 21.76.

Conclusion

Target has entered Canada this year and recent results have shown that the entry was successful. Its entry strategy with Red Card penetration has helped it to achieve this success. In the US, its small format City Target stores have helped it to increase sales. Its partnership with Facebook, Google and eBay will help it to increase sales. I believe it is an attractive buy at current valuations.

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Ash Sharma 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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