Target's frosty Canadian welcome weighs on third-quarter profit

Staff Writer
Columbus CEO

(c) 2013, Bloomberg News.

NEW YORK — Target Corp. is getting the cold shoulder in Canada.

The second-largest discount retailer in the United States, which opened its first stores north of the border in March, posted third-quarter profit Thursday that trailed analysts' estimates after the loss in its Canadian unit was wider than expected.

Target is generating lower-than-projected sales there after failing to provide Canadians with the bargains they were expecting. Rivals also have cut prices to make Target's entry difficult, and Canadians aren't shopping at the stores for basics such as food and medicines like U.S. shoppers.

The Canadian sales troubles, along with the costs of its rapid expansion from zero to 124 stores there this year, combined to subtract 29 cents a share from third-quarter profit, Target said Thursday. That was 7 cents worse than Target forecast and accounted for almost all of the 8-cent gap between the retailer's results and analysts' estimates.

"They had high expectations when they moved to Canada, and they're nowhere close to hitting those targets," Brian Yarbrough, an analyst at Edward Jones & Co. in St. Louis, said today in an interview. He recommends buying Target shares.

The Canadian unit, which added 23 stores in the quarter, generated $333 million in sales in the quarter ended Nov. 2 and posted a $238 million loss before interest and taxes, Minneapolis-based Target said today in a statement. Companywide net income slid 46 percent to $341 million, or 54 cents a share. The average of 21 analysts' estimates compiled by Bloomberg was 62 cents.

The Canadian woes are especially troublesome for Target because it's the retailer's only market outside of the United States, where it has almost 1,800 stores. By contrast, larger rival Wal- Mart Stores has locations in 27 countries, so it can make up for weakness in one market with strength in others.

In Canada, Target is finding that many consumers already had crossed the border to shop at its U.S. locations and have been dismayed that merchandise at locations the retailer opened in their home country wasn't as cheap as they expected. To make matters worse, local chains and Wal-Mart cut their prices before Target opened stores there, with Wal-Mart dropping prices on 10,000 products in July 2012.

With merchandise not moving as quickly as Target had projected, the retailer is being forced to slash prices to clear out the extra inventory. That hurts its gross margin, or the portion of revenue left after subtracting the cost of goods sold. Target's gross margin on sales in Canada was 14.8 percent in the third quarter, less than half of the companywide margin of 30 percent.

Chief Executive Officer Gregg Steinhafel said Thursday on a conference call with analysts that the company is confident it will increase gross margins in Canada into the mid-30 percent range after clearing inventory in home goods and apparel. The company also still likes its store sites, whose leases it agreed to buy from Zellers in 2011 and are in densely populated areas.

"While our initial sales and profits in Canada have not met our expectations, we remain enthusiastic about the Canadian market and confident in the long-term success of these stores," Steinhafel said on the call.

The retailer could use the boost because its business in the U.S. is facing its own challenges as the unsteady economy curtails shoppers' spending. Sales at stores open at least 13 months as well as through its website rose 0.9 percent. Analysts estimated a 1 percent gain. Companywide revenue rose 1.9 percent to $17.3 billion, trailing the $17.4 billion average projection. Wal-Mart also posted third-quarter sales that missed projections as same-store sales at its namesake locations in the U.S. slid 0.3 percent.

While some households are benefiting from the recovering economy, the rising stock market and rebounding home values, a large swath of the population is being left behind. Wages have been stagnant since the end of the recession for these lower- income families, which make up a large portion of the customer base at discount retailers such as Target and Wal-Mart. Hourly earnings adjusted for inflation have been flat on average since June 2009, according to Labor Department figures.

Fourth-quarter adjusted earnings per share will be $1.50 to $1.60, Target said. Analysts estimate $1.56, on average.

"Target is outperforming its closest competitors, but it's still a tough environment out there," Sean Naughton, a Minneapolis-based analyst for Piper Jaffray Cos., said today in an interview. He rates Target overweight, the equivalent of a buy. "The U.S. consumer is still a little bit challenged."