Target Corporation is in the market to deliver a higher quality product and experience to a more upscale consumer than its competitors. This allows Target to have very specific advantages in the competitive environment. The combination of these two things results in unique performance characteristics in financial performance. All of this is combined to make a forecast on the future of Target and a decision to buy Target shares as an investment.
Rivalry among Competition: High
As a discount retailer, some close competitors of Target are Wal-Mart and Costco. Due to the three sellers’ broad product mix, they sell similar or identical items, which leads to intense rivalry in this industry.
Threat of Entrants: Low
There is minimal threat of entry in discount retailing due to the high barriers. These include immense capital requirements, access to good locations, economies of scales and hard to imitate brand identity.
Threat of Substitute Products: Medium to High
Target has many close substitute sellers due to its broad product assortment. However, many of these sellers are just a partial substitute for Target’s departments; for instance, groceries – Wal-Mart, pharmacy – Walgreens, apparel and home goods – Kohl’s. Other big-box retailers require a membership fee to shop at, such as Costco. Thus, no complete substitute can be defined for Target.
Bargaining Power of Suppliers: Low
Target has a variety of suppliers and not a single one accounts for a big fraction of its inputs. Target is also a large volume purchaser, which results in low bargaining power of suppliers.
Bargaining Power of Buyers: Low
Since Target has many buyers and each one only makes up a small portion of the overall sales, it is difficult for any individual to influence the performance of Target. However, due to the availability of substitutes, consumers do have the power to shop elsewhere when need be.
Summary of Present Performance
When performing ratio analysis, there are two ways to benchmark a company. The first method is against itself, comparing the company’s current ratios to those of its past. The second is by comparing the ratios to similar companies (Wal-Mart and Costco in this case). The latter of the two is not as effected by macroeconomic trends but does not give the consistency of the former. Different companies may have differing strategies and accounting methods that would affect these ratios. Therefore, it is good to look into both of these benchmarks while doing ratio analysis. In the first category of ratios, the profitability ratios, Target is the best of the three companies for two of the four ratios and in the middle on the other two. It leads the pack in both return on sales and gross profit margin. In the return on sales ratio, both Target and Wal-Mart peaked in 2010 and have dropped off slightly while Costco has been lower, but more consistent. In gross profit margin all three companies reached a high in 2009, but Target has fallen slightly closer to the Wal-Mart since then. Target is leading these aspects due to their emphasis on quality (which provides for higher margins).
Also, in the past Target has focused less on groceries (which have low profit margin) than the others. However, Target is beginning to sell more groceries in their stores, which may narrow the gap between them and Wal-Mart. In the other two profitability ratios, return on assets and equity, Target falls just below Wal-Mart. Wal-Mart and Target both drop slightly in these ratios from 2009 to 2010 after rising the previous two years. Costco, however had a much lower and steadier return on equity, and a return on assets that fluctuated around Target’s but did not follow the trend. Again, while Target focuses on quality, Wal-Mart focuses on efficiency and cost. Being more efficient with their assets and equity causes Wal-Mart to take these categories. Target was generally the highest in cash health (or cash flow) ratios. In both operating funds and operating cash to current liabilities, Target rose from 2007 to 2009 and then fell from then to 2011.
Wal-Mart also followed this general trend, but averaged slightly lower. Costco again fluctuated differently than the other companies, and had a lower average in the operating cash to current liabilities ratio. This is consistent with the pervious ratios. Target is doing a better job managing its operating activities (has a higher return on sales) and is therefore more equipped to meet its current liabilities. In third group of ratios, the asset management ratios, Target is behind its competitors in every aspect. Target’s receivables, inventory, and asset turnovers were noticeably lower than that of Wal-Mart and Costco. Target only showed improvement in the turnover of receivables ratio (which is clearly evident in the receivables collection period). The other companies were fairly consistent in each of these ratios. Also, in looking into the quarterly data, Target seems to be more affected by the Christmas period than do the other companies.
This shows that Wal-Mart is more efficient in the use of its assets, receivables, and inventory than Target. Finally, the liquidity and solvency ratios show mixed results. Target is generally the lowest in the cash and marketable securities to total assets ratio. Costco and Target have highs in 2008 and 2010, Wal-Mart remains close to level. Target’s quick ratio was by far the highest from 2007 to 2010. While the others remained constant, Target slowly lowered until a large fall in 2011. This is in part of the Zellers expansion and a rise in receivables. In the accounts payable turnover ratio, all the companies remained fairly consistent, with Target always the lowest number.
These again show that Target is in the best position to meet its short term liabilities but is not as productive with its assets. Moving on to the solvency ratios, Target had the highest in both long term debt to total assets and to shareholder’s equity. Target peaked in both of these ratios in 2008 and fell from then until a slight increase from 2010 to 2011. Wal-Mart and Costco both followed a similar pattern. This decrease in use of debt was in preparation for debt financing of the Canadian expansion. In the interest coverage ratio, Target was just lower than Wal-Mart and higher than Costco. Target remained fairly constant in this ratio, as did Wal-Mart. Overall, these ratios show that Wal-Mart and Costco are generally more prepared for bad times, while Target thrives when the economy is good.
Summary of 2012 and 2013 Forecast
Over the next few years Target’s future is full of opportunities and risks. The most important factors to consider are revenue, expansion in grocery, and the Zellers acquisition. Consumer spending makes up 70% of the U.S. economy. With the unemployment rate still around 8%, above its historic average of 4.5%, we see continuation of the slow recovery from the recession a few years prior because consumers have less money to spend. This does not make us feel good on the outlook for Target as they provide the market with slightly higher priced goods. Management has combated this with the introduction of Target Red cards. This allows customers to get a 5% discount on anything they buy in store and free shipping online. In test markets, penetration has risen to 20% of all customers. Red card discounts combined with remodeled stores, have brought in more traffic.
In a move to compete more with Wal-Mart, Target has continued to roll out its “P-fresh” concept to more stores. These remodels add more grocery selection to Target, making it a one-stop shop for everything that you need to buy. Combined with Red Card, this has helped drive more traffic but both have, and will continue to, hurt margins. The most significant event in Target’s near future is the acquisition of the Canadian based retailer, Zellers. Target acquired this discount retailer in 2011 and will not be opening its first store until the first quarter of 2013. This means that throughout 2012 Target will be remodeling these stores, building 3 distribution centers, as well as hiring and training these employees. Overall, in 2012 there will be a lot of investment in assets not producing any cash flow. Thus, lower efficiency and profitability ratios across the board. Once these stores are operating, we do see this acquisition benefiting Target heavily in future years. Stock Recommendation and Justification
In this case discounting cash flow model has been used to evaluate the equity of Target. The future forecast has been divided into two time periods – a specific forecast period (2012 -13) and the period thereafter (2014 onwards). The initial step is to calculate the free cash flow for each forecasted year. Operating cash flow has been lower in the 2012 and 2013 because of the selling, general and administrative expenses due to the expansion of Target in Canada.
After the acquisition of Zellers and Target’s expansion in Canada with around 220 operational stores by 2014, the operating cash will rise to $5,151 million. The net cash and cash equivalents required to sustain business will thereby be $500 million. The cash investments required to sustain business will be $2,339 million. We therefore calculate the perpetuity free cash flows to be $1,562 million. In the end, the sum of all the present values of future expected cash flows turn out to be $52,596 million. The present market value of equity for Target is $40,000 million. Since, the expected future value is more than the present market value, we recommend buying stock in Target.