When Wal-Mart (NYSE:WMT), Target (NYSE:TGT), and Costco (Nasdaq:COST) all see relatively uninspiring same-store sales growth trends, I think it's safe to say the U.S. retail market is not in the best of health. Although Target continues to take steps that should improve the company's long-term competitiveness and growth profile, Wall Street is generally very much focused on the now and underperformance creates some challenges for the shares.
Fiscal Second Quarter Results Come In A Little Mixed
Target reported 4% sales growth in the fiscal second quarter, a result that was just a bit shy of Street expectations. Same-store growth of 1.2% was below the average expectation of 1.8%, and traffic was down more than 1%.
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Although Target did see a little bit of gross margin improvement, the number was still about 30bp shy of expectations. On a more positive note, though, SG&A expense control was a bit better than expected and the 10% decline in operating income led to an adjusted continuing operating result that was basically in line with expectations.
Even Wall Street usually understands that it takes money to make money, and analysts and investors were expecting some dilution from Target's foray into Canada. Based on these early results, though, it looks like “some” dilution is turning into quite a bit.
The effective operating margin for the Canadian operations was a negative 62% this quarter, and they diluted EPS to the tune of $0.21 per share this quarter. It also doesn't help matters that sales appear to have come in well below expectations, as the $275 million in sales were below the midpoint (in the neighborhood of $325 million) of the range of published estimates I've seen. With all of this, Target management has nearly doubled the expected dilution from Canada for FY 2013.
I think it's also worth noting that the Canadian retail environment is getting more competitive as well. Wal-Mart has stepped up its store growth in Canada, and other rivals like Costco, Sobeys, and Loblaw have looked to grow their businesses and compete more aggressively on price against this new entrant.
Tougher Today, But Building In Some Cogent Ways
I don't have many reassuring things to say about the state of the U.S. shopper, nor the back-to-school shopping season. It's pretty clear that shoppers are feeling a pinch, particularly on the lower end of the income spectrum.
I also wonder, though, if shoppers are reallocating their spending. I can't help but notice that comps have been pretty good (if not great) at stores like Home Depot (NYSE:HD), Pier 1 (NYSE:PIR), Williams Sonoma (NYSE:WSM), and Lowe's (NYSE:LOW), so I think there may be something to the idea that consumers have different priorities for their spending these days.
On the other hand, I do like some of the moves that Target has been making. The acquisitions of Cooking.com, CHEFS Catalog, and Dermstore should help improve the company's online offerings (where Target has lagged Wal-Mart and certainly lagged Amazon (Nasdaq:AMZN) and also augment the company's merchandise assortment and margin potential. I'm a little less sold on the Beauty Concierge program and whether this can grab business from retails like Ulta (Nasdaq:ULTA), but it's at least a concept worth exploring.
The Bottom Line
At least some sell-side analysts have been boldly arguing that Target needs to make a bigger plunge in international retailing. Given the difficulties in Canada and the challenges of other retailers in emerging markets (Wal-Mart in Mexico and Brazil, Tesco in China), I hope they reconsider that position. It's not so much that I believe Target can't profitably grow overseas, but the company needs to show it can crawl before it starts trying to sprint.
I'm pretty ambivalent about these shares right now. It would seem that retailers more oriented to durable house-related merchandise is the place to be today, and Target's shares don't seem cheap enough to make a value call yet.
Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.