They say to never bet against the American consumer, but when it comes to retailers, there is always an opportunity that presents itself on the long and short side of the investing world. We may not see the opportunity right away, but it's always there. Furthermore, and most unfortunately, the opportunity usually passes us by. It happens almost every single decade and sometimes it happens more than once… the 'big retail bust'! This article will serve as the first of a planned three part series outlining the potential decline for Target Corporation (TGT).
The most recent "big retail bust" has come from the name Best Buy (BBY). At one time, not too very long ago, Best Buy was the darling of the retail world. It wasn't more than 13 months ago that shares of Best Buy were trading above $40 a share. Of course this was before major hedge funds and institutions decided that something was terribly wrong with revenues and earnings coming in from the retailer YoY. As these major shareholders bailed on the electronics retailing giant, the slow slide in share price turned into a precipitous decline that would last for another 12 months, bringing shares of BBY well below $15 a share. The question is: what went wrong with the leading electronics retailer over the last year? The answer is quite simple, nothing. But nothing was ever really right for Best Buy, in our estimation.
The problem was/is the general business model employed by BBY. It was a treacherous plan to begin with in any type of forward looking economic understanding or competitive understanding. We would go one step further and say that management, which is highly engaged by the nature of its own business and product mix, simply fell asleep at the wheel.
Getting back to the question above, nothing went wrong other than the business model was set up for failure from inception. It's electronics folks, electronics. Unless you can find a way to deliver margins above 35% in this industry, it is just a matter of time before big brother topples you over. By big brother, of course we mean the likes of Wal-Mart (WMT) and even Target, presently. We will come back to the word presently as it pertains to Target only.
Do you remember Service Merchandise? We sure do, but the company liquidated assets and went through bankruptcy in the late 90s. Maybe you remember a more recent electronics retailer folding under in 2005: Circuit City. Of course there is still a smaller version of Best Buy scratching to stay alive, Radio Shack (RSH). Shareholders of Radio Shack have little hope left other than the possibility of a potential private equity take over and/or take out. Last, but not least on our list of failed office and electronics equipment retailers is COMPUSA which in 2008 sold most of its assets and liabilities to Tiger Direct, a subsidiary of Systemax (SYX). Again folks, it's electronics and unless you can find a way to get margins to grow steadily above 35%, it's just a matter of time.
Best Buy attempted to be the "be all and end all" of electronics retailers, the consumer's number one choice for everything from television sets to mobile phones, and for a while it worked. But then came the extension of the electronics product line of Wal-Mart and the advanced pricing of Amazon.com (AMZN) and other e-commerce electronic retailers for which Best Buy had a difficult time competing against. Best Buy eventually caved under the structure of its sheer size, operational structure, store format and heavy overhead costs.
Best Buy isn't quite dead yet, as the company attempts to streamline operations and defines cost cutting measures by closing under-performing stores and establishing smaller prototype stores to accompany its smaller Best Buy Mobile stores opening around the country. In the case of electronics retailing, smaller sometimes is better. Will this change in store format and delivery to the end-user (consumer) be a winning strategy that will return Best Buy to its former glory? Time will tell.
Believe it or not, this article really isn't about Best Buy, it's about identifying trends and the underlying opportunities that may present themselves. So what do we need to identify the trends? Balance sheets? Channel checks? While these things can certainly be used as tools, historic consumer trends, disciplined understanding of the retail world and infrastructure are going to be the most fundamental identifiers of opportunity. Having said that, a keen understanding of a company's operations is usually the number one "tell" when it comes to a long-term investment.
The remainder of this article is going to focus on two retail giants, the biggest of the big boys if you will. We are looking directly into the ring and positioning Target versus Wal-Mart. Furthermore, we're not even going to bring the two company's respective balance sheets into the equation for the basis of this article. This article will outline the fundamental thesis which sees Wal-Mart overpowering and potentially eliminating Target from the retail landscape in its current format. Keep in mind the term current format as we have related it to characterize the future for Target Corporation.
First and foremost let's outline that these two companies do cater to a different demographic consumer. However, inevitably they need to benefit from their non-target demographic as well to be successful in an ever-increasing competitive environment from both brick and mortar retailers and e-commerce retailers. We are all probably well versed in the Wal-Mart versus Target story as these two giants fight over the valuable consumer dollar. So rather than bore you to tears, let's start with consumables, which is where Target is attempting to right fit its respective product mix.
The Super Target format has been an uphill battle for Target since 2000, as it has learned that competing with Wal-Mart on a grocery format has proven unprofitable. Did Target come to the grocery party too late or did it do grocery wrong? If you ask a Target Store Team Leader (General Manager) who has been around since 2000, he would have to admit that the early concepts were not in-keeping with margins of the general store format. The high maintenance expense of the grocery format was a terribly new concept for which Target had to overcome and overcome quickly. Unfortunately, it did not and until 2010 the company was still incurring marginal losses from its grocery segment, which ultimately fed into the hard-lines segment of the business.
In 2010, the company began rolling out its new and improved P-fresh grocery format which focused more heavily on high turnover grocery segments such as fruits vegetables, fresh foods and more. Three years later, the company is still managing this revamped version of the general grocery format instituted by the company over 15 years ago. Just like with electronics, this is grocery folks, and there is less than 15% margin in the overall category, leaving very little room for error in an already highly competitive business segment.
The average Target store is 12-21,000 square feet smaller than a Wal-Mart store and this is probably the strongest bull point working in favor of Target should it choose to right fit the company's stores some day. Although I have highlighted the challenges for consumable profitability facing Target, this is not the first product category the company has had issues with.
When was the last time you saw a Target Lawn and Garden Center? I'll tell you; it was in September of 2010. As of September 2010, the company closed the last of its unprofitable Lawn and Garden centers which was effectively the closing of all the company's Lawn and Garden centers. These closures were the right move for Target and could arguably be seen as the company's first effort to right-fit store formats and boost dollar-per-square foot metrics as many closures created additional warehouse space for individual stores, thus allowing the flow of greater quantities of merchandise into stores.
Unfortunately, the company hasn't kept pace with other retailers when it comes to increasing SKU count in stores. While they are certainly increasing the number of SKUs or new products offered, for every singular SKU introduced at Target, Wal-Mart is introducing 4. This relative fact is no more evident than when one views an end-cap product placement location in a Target store, there is usually a great many gap spaces between shelving fixtures. Sure the paper backing and visuals look great at Target, but that's not helping to sell more products.
So does Wal-Mart succeed with Lawn and Garden Centers? No, it absolutely does not, but its sheer scalability has enabled the company to overcome any marginal losses incurred in this product category and therein lies the identifiable difference between the two companies. What was the last product category which Wal-Mart has scaled away from? If anything, the company embarks or pushes deeper into product categories. It's as if Wal-Mart has the wrong puzzle piece, but still forces the angular edges to fit, no matter what.
Using an "apples to apples" comparison, let's take the product line offered at both retailers: SodaStream (SODA) products. SodaStream offers home carbonation machines, syrups, bottles and CO2 canisters. Wal-Mart offers six different carbonation machines in stores and on-line while Target offers five. Wal-Mart offers the CO2 exchange at almost all store locations and Target offers the CO2 exchange at roughly 110 locations presently (may include all locations in the near future). Wal-Mart offers all of the same flavored syrups which Target offers plus an additional 10 flavored syrups.
Another failed seasonal product category which Target launched in 2005 was called Global Bazaar. This international collection of brand home furnishings and accent pieces exited Target's annual planned product categories in 2009 as nearly 63% of the product category saw steep price reductions after 3 weeks of shelf life. Target was attempting to establish a longer-term product category aimed at the Pier One and Pottery Barn clientele. The average accent piece in the Home Bazaar category was $69.99. The product category range was from $24.99-$299.99.
What is painfully apparent in the recent product assortment discontinuations at Target is that its target clientele demographic is very finite and could possibly be limiting future growth opportunities for the company. Target has been struggling with many departments in the hard-lines category for the last few years. Global Bazaar falls into this very category and nearly 45% of the Target store footprint is devoted to hard-lines. Yes, electronics also fall into the hard-lines category, in case you were wondering.
Much was made concerning the recent agreement between Apple Inc. (AAPL) and Target Corp. The agreement outlined that Target would dedicate and lease space to deploy Apple store's concept inside Target stores. Some 25 stores would test this pilot program in the near future to see if the Apple consumer can drive foot traffic and increase the average receipt price for Target. This agreement with Apple is one more example of the company's newfound plan to introduce the store-within-a-store concept going forward.
As we round out this article discussing the potential decline for Target Corp, relative to the competitive landscape and juxtaposition of the economic climate, we can't help but to reflect upon and identify the factors resulting in the changes that have taken place at Target over the last decade. The Super Target format expanded through 2007 and then has dramatically curtailed since. Lawn and Garden Centers have vanished. The Electronics and Entertainment department has expanded (E&E department). Mainstream hard-line goods have seen consistent product cycling out of the normal product mixture. Lastly, and something we will focus on with my second article is the soft-lines product cycling mixture. Soft-line goods tend to have a shorter shelf-life, higher profit margin and speak to the core Target consumer…so why the abundance of clearance racks per square foot? When do soft-line sales declines mirror hard-line sales declines? It has happened to Target before, but with greater margins per square foot than the potential of the current store format. And that, investors, is the lasting identifier I will leave you with; margin potential vs. sales decline impact. What could this look like for Target Corp should it come to fruition one day?
Disclosure: I am long SODA.