Target Looks To Score In Canada

By Will Ashworth | February 15, 2011 AAA

When you're as big a retailer as Target (NYSE:TGT), finding growth isn't easy. You can try to grow organically but there's no guarantee you'll do it. An easier route, as Walmart's (NYSE:WMT) proven, is to buy a similar business in another country. In November, the world's largest retailer bought 51% control of Massmart, a South African wholesaler. Target seems to have taken notice. In January, it announced it paid $1.85 billion for 220 leasehold interests from Canadian retailer Zellers Inc. This is Target's first international expansion. We'll look at why this should kickstart future growth.
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Canadian Expansion
Target's long been rumored to be expanding into Canada. In 2004, it explored buying Zellers from Hudson's Bay Co. but nothing came of it. As recently as 2010, management suggested expansion wasn't imminent. So what changed? Timing. NRDC Equity Partners bought Hudson's Bay Co. in July 2008 for $1.1 billion. Richard Baker, NRDC CEO, went to work revitalizing the Canadian retail icon along with its Zellers chain. The Bay makeover seems to have worked but Zellers continues to struggle. At the same time, Target watched as American retailers like Genesco (NYSE:GCO), True Religion (Nasdaq:TRLG) and Limited Brands (NYSE:LTD) committed big dollars to Canadian expansion. With the Canadian economy continuing to outperform the US, it became clear that if it wanted to expand, Canada was a natural fit and NRDC was now in a position to make a deal. Almost two decades ago, Target had an opportunity to buy 122 Woolco stores in Canada but lost out to Walmart. I'm sure it didn't want a repeat performance.

Future Growth
American retailers tend to do better in Canada than back home, both in terms of sales per square foot and profitability. According to the International Council of Shopping Centers, Canadian retailers generate $578 sales per square foot at the malls compared to $398 in the United States. Retail analysts predict Target will generate sales per square foot of $300 in Canada, 50% higher than what Zellers currently does. This will lead in short order to $7.5 billion in revenue from a $2.85 billion investment. It ought to be able to recoup its investment in just five or six years.

I'm going to assume it generates this revenue within five years. I'm also going to assume that its operating margin for these stores will be 10%, 200 basis points higher than what it generates in the U.S. That's $750 million in operating profits. In the U.S., I'll apply 3% sales growth in each of the next five years. This should produce operating profits of $6.7 billion for a grand total of $7.8 billion. Take half that for interest and taxes and we're left with $3.90 billion or $5.51 a share. It's not a huge bump from current numbers, but it is material.

Bottom Line
Target still has to execute its plan for Canada and that's no given. However, it's a bet I'd be willing to take. After all, look at the growth Walmart experienced once it moved beyond its borders. The same can happen for Target. (The increase in communications technology has companies competing in a global market, which has a major impact on a country's economy. Check out How Globalization Affects Developed Countries.)

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