Target (NYSE:TGT) is scheduled to release its Q4 fiscal 2013 results on February 26. While the company struggled to grow during the first three quarters of fiscal 2013, we expect Q4 to be worse. In addition to the weak consumer sentiment in the U.S., low store traffic and a major data breach weighed heavily on Target’s sales during the holiday season. That is why the retailer lowered its Q4 EPS guidance from $1.50-$1.60 to $1.20-$1.30, with an expected decline of 2.5% in comparable store sales.
Extreme weather conditions in December and January prevented U.S. buyers from venturing out to store shopping, which impacted the sales of a number of retailers including Target. Concurrently, more consumers shopped over the internet, which did not help Target’s results due to its extremely small online channel. Additionally, the retailer’s sales declined substantially after it reported that credit card and other information of millions of its customers was stolen from its retail scanning system from the onset of holiday shopping through in mid-December, when the breach was discovered. Overall, personal information of more than 70 million individuals was stolen during the breach which includes customers of Target (40 million), Neiman Marcus and other retailers. ((Cost of Replacing Credit Card After Target Breach Estimated at $200 million, The Wall Street Journal, Feb 18 2014))
Our price estimate for Target stands at $74, implying a premium of around 20% to the market price.
Fall In Store Traffic & Weak Apparel Sales Will Put Pressure On Sales Growth
Pressured by the weak economic environment, U.S. buyers were extremely cautious about their spending last year. This was clearly visible in the recently concluded holiday season as the U.S. retail industry saw its weakest growth since 2009. Moreover, extreme weather conditions prevented buyers from store shopping. As a result, U.S. foot traffic declined by almost 17.7% in December 2013 as compared to December 2012. Overall, foot traffic during the holiday season decreased by a notably large 14.6%, which was significantly higher than ShopperTrak’s earlier prediction of 1.4% decline. Recently, retail giant Wal-Mart (NYSE:WMT), stated that winter storms impacted its store traffic throughout the quarter, resulting in weak sales. We expect Target to have felt this impact too.
Also, while U.S. buyers spent freely on electronics, furniture and building materials, they were hesitant to spend on apparel, which is a big product category for Target. According to a Reuters poll conducted before the holiday season, about 27% of consumers were planning to lower their spending on apparel this holiday season. Target had already anticipated a weak holiday season for the U.S. retail market, which is why it reduced its holiday hiring back in September.
In January, retail growth failed to pick up as consumer confidence slipped and the U.S. witnessed record cold and heavy snowfall that prevented store visits. The Thompson Reuters/University of Michigan’s consumer sentiment index fell to 81.2 in January from 82.5 in the previous month. Due to these factors, we believe that Target struggled to drive traffic despite its attractions such as rewards programs and limited edition/exclusive product range.
Small E-Commerce Business Prevented Target From Enjoying The Online Boom
Despite the heavy fall in foot traffic, U.S. retail sales managed a modest growth of 2.7% during the months of November and December. This is attributable to the fact that U.S. buyers shopped online. The decline in store traffic due to harsh weather somewhat complemented the strong rise in online orders. The surge was such that United Parcel Service (NYSE:UPS), one of the largest players in e-commerce delivery, was unable to deliver several orders on time. Also, apparel retailer Abercrombie and Fitch (NYSE:ANF) saw the revenue share of its online business escalate from 16% to 25% in December.
While this trend favored the retailers who drive substantial web traffic, players with smaller e-commerce channels were unable to benefit from it. For Target, online revenues account for an immaterial portion (does not report) of its overall sales. Therefore, even if the retailer’s online revenues had increased substantially during the quarter, a heavy fall in foot traffic would have easily subdued its impact.
Data Breach Resulted In Weak Sales
Half way through the month of December, Target revealed that its systems had been breached, allowing hackers over a period of weeks to capture credit card/debit card data along with names and email of millions of its customers. Last month, the company stated that while its sales were going better-than-expected before the breach, they were meaningfully weaker after disclosure of the breach. We believe that customers bought less at Target as they felt that their credit card/debit card security had been compromised. Target later sent an email to its guest apologizing for the breach and assuring them zero liability for fraudulent charges.
However, we do not expect the data breach to have any long term impact on the company. Financial institutions have already replaced about 85% of cards affected by the data breach at Target free of cost. Also, consumers still maintain a strong interest in the retailer as polls conducted in Minnesota after the breach found that only 5% of consumers decided to stop shopping at Target. We believe that even they will come back to the retailer gradually. Nevertheless, the impact of the data breach will weigh on Target’s upcoming Q4 results.
Disclosure: No positions