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I read a lot of sourced information, channel sales data and articles related to Target in the weeks leading up to Target's (NYSE:TGT) Q3 2013 Earnings release. I was pretty shocked to see the bullish sentiment expressed by a number of author and investors as they outlined reasons for buying shares of Target ahead of the retailer's earnings release. Given the trend in same- store- sales results earlier in the year and in the light of a government shutdown which occurred during the 3rd quarter, which notably curtailed consumer confidence in October, Capital Ladder Advisory Group wasn't expecting a very robust quarter out of the retailer at all. In fact, we had outlined for investors a very detailed article earlier in the year in which our bearish sentiment toward the retailer was on full display. Since nothing has changed in the economy or the consumer spending landscape as a whole since that time, our view on Target as an investment opportunity hadn't changed either. But that is obviously what makes a market, right? So let's discuss Target's 3rd quarter report and see where it takes us.

Q3 2013 Results

Target managed to come in with earnings of $.84 a share, just below the midpoint of its guidance of $.80-$.90 per share. Earnings were once again pressured by a greater than expected dilution in earnings from the Canadian segment. While gross margins expanded modestly in the U.S. business segment, gross margins from the newly-formed Canadian business were a dismal 15 percent. As we recognize the greatest portion of Target's business is still very much in the U.S., we focus on how the company's existing stores are performing. Through much of 2013, same-store-sales (SSS) have been underwhelming. In the 1st quarter of 2013, SSS declined by .6% and in the 2nd quarter of 2013 SSS increased by only 1.2%. While expectations for SSS in Q3 were modestly offered in a range of 1-2%, Target missed the bar again, albeit narrowly, coming in with SSS growth of just .9 percent.

Guidance Reduced

Now let's take a look at Target's lowered 4th quarter and full year guidance. Target is expecting to see continued earnings dilution from the Canadian segment. The company forecast is for the Canadian segment dilution in the range of $0.22 to $0.32 in the fourth quarter. Combining the expectations or adjusted EPS, Canadian segment dilution and $0.02 impact from the reduction in the beneficial interest asset the company expects fourth quarter GAAP EPS in a range centered around $1.26. For the full year, the expectations are for adjusted EPS in the $4.59 to $4.69 range, down slightly from last year's performance of $4.76.

Operational Activities in Q3 2013

On the surface this decline in earnings year-over-year looks quite ominous, however, if the company manages to streamline inventories, operations and distribution channels in its Canadian segment, earnings growth might return next year. This year, Target expects to successfully open 124 Target stores in Canada and only has another 20 or so stores to go to successfully achieve this goal by the end of the year. Canada is proving to be a challenge for Target although it does not have high expectations from the segment in its infancy stage.

In addition to obstacles with advancing its Canadian business segment, Target is feeling the continued consumer crunch as it pertains to discretionary spending habits. Target's higher-margin apparel and home categories both saw small declines in comparable sales during the 3rd quarter, but this is nothing new for Target as in 8 of the last 10 quarters the retailer has borne out similar results. Through much of 2013, its seasonal category of goods has also witnessed YOY sales declines. This trend only increased during the 3rd quarter as Target saw lower-than-expected sell-through rates on Halloween merchandise.

Moreover, this year's tax increase is being felt more broadly over the lower and middle income demographic consumer whom is making fewer trips to the department store as indicated in the number of transactions occurring at the retailers more than 1,800 stores. The government shutdown, which occurred during the 3rd quarter, also produced a dramatic decline in consumer sentiment adding to the already cautious consumer spending trend which was mentioned on the conference call by company executives on numerous occasions. Target's core demographic consumer is right in the middle of the upper-end and lower-end consumer and is feeling the pressure to aggressively market and promote its products to the middle-end consumer who is being squeezed at both ends.

It has been a rather difficult year for Target as the retailer has been expanding into Canada and remodeling stores here in the United States while implementing new tools to try and foster greater foot traffic, sales and REDcard conversion rates. Target outlines its growth of REDcard each and every quarterly conference call for investors so investors and analysts can track the conversion rate and weight its relevance with regards to foot traffic, sales and gross margin impact. REDcard penetration grew beyond 20% in October and averaged just below 20% for the full quarter.

The company has made strong in-roads into the digital and mobile channels through partnerships with Facebook (NASDAQ:FB), Google (NASDAQ:GOOG) and eBay (NASDAQ:EBAY) in most recent quarters. In the 2nd quarter of 2013, Target launched Cartwheel, a joint collaboration with Facebook. Cartwheel now has nearly 3 million users most of whom access it exclusively on their mobile device. Even though Target launched Cartwheel only six months ago, guests have already saved more than $14 million. Target's EVP of Merchandising and Supply Chain, Kathryn Tesija, suggests that Cartwheel is helping to increase customer visits. She also believes that Cartwheel is helping basket dollars because customers are using Cartwheel in the store on their mobile device looking for deals on things that they want to buy and they're adding more to their basket. Target has moved to integrate Cartwheel into the Target app for both Android and iOS in time for the holiday season. Now, guest can find Cartwheel deals in four places; on their shopping list, on the product listing page, on the product detail page, and the "What's In Store" content section.

As noted earlier, Target is continuing with efforts to monetize its digital channels. The retailer continues to see double-digit growth in overall digital traffic and triple digit growth in mobile. This is notable because mobile is a much higher percentage of their digital traffic compared with some of Target's closest competitors. Additionally, Target is also witnessing improved conversion on both the traditional side and on mobile, as the company continues to benefit from investments to improved search and navigation optimization.

During the 2nd quarter of 2013, Target began experimenting with same day delivery through eBay and Google in select cities. An adjacent program also began in the 2nd quarter known as in-store pickup. With the test of this program now in the rear view mirror and with positive responses from guests, Target launched the program chain wide on November 1st.

Target's Beauty Concierge service has also borne some early success in the first half of 2013. Since rolling out this program in test stores earlier in the year, during the 3rd quarter Target expanded this service program to another 95 stores including stores in New York, New Jersey, San Francisco and Dallas-Ft. Worth. These beauty consultants are brand agnostic and provide guests with detailed, unbiased information on all beauty and personal care categories in the store including product attributes and ingredient benefits servicing as a knowledgeable source and a friendly face in what can often be an intimidating category. This strategy of beauty consultation is unique to Target in that the beauty consultant can willingly speak to any and all products and product categories within the cosmetic portfolio of products. Target has noted that this program is exceeding its sales goals and the retailer is seeing particular strength in core categories like cosmetics, skincare and hair care due to the response from the Beauty Concierge service. But this is just one service which Target is extending to its guests as another subscription-based service recently launched during the 3rd quarter.

In late September, following a three month team member pilot, Target rolled out a subscription service that allows guests to order baby diapers, training pants, wipes and formula to their doorsteps on a recurring schedule. Target's subscription service has unique advantages, including free shipping and easy in-store or online returns, 5% off subscription purchases when using Target credit or debit card, and an assortment that includes national brands and popular own brand products like up & up diapers. Based on the initial guest response, Target is now considering a plan to expand the subscription service to more categories by the end of the year to learn more about guest interest in this type of service. For example, Target will be adding a limited assortment from categories like coffee, personal-care, paper towels, and toilet paper. It sounds very much like Target may eventually aim to differentiate itself from the competition with the availability of total purchase home delivery services.

Lastly, but certainly not least, in the 3rd quarter Target opened their eighth CityTarget and continues to be pleased with the results from this new format. Target opened their first CityTarget stores more than a year ago and is seeing very strong comparable sales growth in these locations, as they raise awareness of frequency categories and communicate the breath of the Target product assortment and the great values they aim to deliver across the store.

As Target exits the 3rd quarter and enters the 4th quarter and the busiest shopping time of the year, the retailer has to contend with not only the competitive landscape of the retail industry, but it must do so in a shortened time frame. This holiday shopping season brings about the loss of six shopping days between Thanksgiving and Christmas this year, which is just one of the many reasons Target is entering the holiday season with a cautious optimism, as the retailer annualizes over last year's election and consumer uncertainty surrounding the fiscal cliff. On Thanksgiving Day, Target expects to open at 8pm based on the response to Thursday's opening last year and the higher number of families who shop together. This year, Target has pushed forward its opening time by one hour to help accommodate guests and remain competitive in the marketplace as Wal-Mart (NYSE:WMT) will be opening at 6pm on Thanksgiving Day. Another example of how Target aims to be competitive in the marketplace this holiday season is through leveraging its e-commerce business. Target.com will feature 15 online-only daily deals for two straight weeks beginning Sunday, November 24. The only exception will be Thanksgiving Day, when hundreds of Black Friday deals, including almost all of the in-store deals will be available starting in the early morning hours. Also on the two days before Thanksgiving, Target.com will be running a special REDcard preview sale with 25 exclusive offers for REDcard guests in items ranging from electronics and entertainment to toys and housewares.

With Wal-Mart's ever-expanding holiday promotional campaigning and promoting, Target has to match the retailer on both pricing and marketing in order to drive foot traffic and sales. To raise awareness of its offers, Target is increasing media weight over last year and concentrating efforts during the entire week of Black Friday with TV, digital, cinema, and radio support. This will be the most digitally enabled holiday campaign in Target's history with an enhanced presence in digital and mobile channels where the retailer believes their guest are frequently engaged.

Some of Target's softest sales categories just so happen to be the two which offer the greatest gross profits, Apparel and Home. With this in mind and in an effort to jumpstart regional sales and promotions, Target announced it is going to test a new holiday pricing promotion in Northern California during the 4th quarter. This week, Target will be testing a special offer in Northern California stores where all apparel and accessory items will be 40% off from the timely open on Thanksgiving through close of business on Saturday. This offer will be available in 89 stores and will include women's, men's, kids, baby, apparel, along with jewelry, accessories, and shoes; the only exclusion is clearance items. Depending on the success of this promotion, Target will determine whether to extend a similar offer in other markets in future years.

Investment Thesis

This holiday shopping season is going to be the toughest Target has faced since 2008. In our opinion and with current headwinds in place regarding consumer spending, department store sales data, continued pressure on gross margins, increased promotional activity, reduced foot traffic and fewer days in the holiday shopping season YOY, we believe that Target will see better days ahead, but not necessarily until some of these trends abate. Target has noted its desire and ability to return roughly $4billion to shareholders possibly in 2014 through lessened CAPEX spend in FY14. This year's expansion into Canada has resulted in a very capital intensive year for the retailer and has resulted in an expected decline in earnings year-over-year. By 2014, Target expects to save approximately $1 billion as it leverages CAPEX down year-over-year. At present, we remain bearish on shares of TGT and will follow up this quarterly recap with additional details outlining the reasons for our bearish sentiment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Target Q3 2013 Earnings Recap

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