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Discount retailers are still nowhere close to pre-crisis growth performance levels and are continuously facing tougher competition within the United States as smaller drug stores are expanding their product lines to attract a larger customer base. However, the latest same store sales numbers declared for September uplift the slowdown of the first two quarters. The entire discount retail sector reported same store sales of 8.6 %. Costco’s (NASDAQ:COST) same store sales registered at a whopping 12.0% and Target Corp. (NYSE:TGT) posted a 4.1% gain.

Competitive Environment

Wal-Mart (NYSE:WMT), the biggest U.S. discount retailer, holds a market cap of $187.9 billion and Costco Wholesale Corp. has a market cap of $35.4 billion. Target Corporation, with a market cap of $34.6 billion, faces tougher competition from within the general merchandise discount sector. All three competitors proclaimed revenue growth for 2010, but the slowest growth - with 3.11% - was attributed to TGT as compared to COST‘s growth which reported a 9.13% increase. From another perspective, Target’s gross margin of 30.02% outperformed both WMT’s and COST’s, reporting 25.09% and 12.64%, respectively. WMT declared a strong ROE of 23.61%, compared to TGT’s 18.94%, and Target ’s EBITDA margin of 10.88 indicates TGT is well ahead of its competitors.

Costco took the lead in same-store sales growth for 2010 with 7%, whereas Target reported only a 2.1% increase, and Wal-Mart suffered a 0.6% decline for the same year. Compared to its nearest competitors, TGT reports the highest leverage, with a total debt to capital of 50.38%, compared to WMT and COST which check in at 41.17%, and 15.03%, respectively. The higher debt usage of TGT is accounted for in its Altman Z-score of 3.35, which is discernibly lower than both WMT’s and COST’s, 4.67 and 5.21 scores. The Altman Z-Score tests the probability of a firm entering bankruptcy. Scores above 3 demonstrate an unlikelihood using this tool. In addition, TGT’s lease adjusted leverage of 2.3 x, is well above the retail & apparel sectors of 1.3 x.

Macro Factor

Target’s strong brand recognition and presence in the North American market created a loyal customer base and is the cornerstone to its overall success. Greater focus on differentiating its product offerings with superior merchandise, compared to Wal-Mart, enhanced brand value gave an advantage in price positioning. Contributing to these factors is the recognition of current market opportunities, such as the focus on smaller stores, growing expansion of the Pfresh grocery section, international expansion into Canada, and continued innovations of Target’s website.

However, the retailer’s few weaknesses are its extreme dependency on products from China, lack of presence in the international market and higher prices compared to its competitor Wal-Mart. Increased regulations on credit cards, product similarities, stronger rivalry from smaller drug stores offering produce, and lower consumer spending are some of the outside threats Target encounters.

As with most retail businesses, Target’s revenue strongly depends on the country’s Gross Domestic Product (GDP) as well as consumers’ Disposable Personal Income (DPI). Annual percentage change for GDP fell from 4.95% to negative 1.74% from 2006 to 2009 respectively; DPI declined from 5.12% to 0.75% for the same time period. This economic downturn is reflected in Target’s slow annual revenue growth of 2.30% in 2008 and a merely 0.88% increase in 2009. As GDP and DPI strengthened in 2010, Target was able to capture a revenue increase of 3.71% for the same year.

International Expansion: Canada

Due to strong competition from other retail discount stores, online retailers and smaller drug stores, the growth potential for Target is unequivocally costly. Management plans to renovate current stores to expand the Pfresh produce segment, and invest in future smaller stores with capital expenditures estimating to $2.5 billion in 2011. Target is moving into the Canadian market. With its first international move, it entered into a commitment on January 2011 to purchase leasehold interests in 220 sites from Zeller Inc. for C$1,825 million, with payments due in May and September 2011.

The company is expected to open 100 to 150 new Target stores, primarily in 2013 with additional expected renovation costs of C$1 billion. This will further increase TGT’s capital expenditures and slow the firm's share buyback program, according to management. Furthermore, management predicts to increase annual dividends and expects sales to reach over $100 billion and to double its EPS by 2016/2017 as a result of the 5% rewards program and enhanced Pfresh segment.

Competitor Wal-Mart Stores announced at the beginning of 2011 to reduce prices for fruits and vegetables, as well as committing to build a number of smaller “Express stores”. A direct result of rigorous market testing resulted in the “Wal-Mart To- Go” program, allowing customers to order products through Wal-Mart’s website, and have them delivered to their front doors. Smaller front stores such as Walgreen (NYSE:WAG) and CVS are also moving towards offering broader grocery products to its customers.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Target, Wal-Mart And Costco: Retail's Competitive Environment