Target Earnings Call Insights: Transaction Weakness and Incremental Canadian Dilution

Target Corporation (NYSE:TGT) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Transaction Weakness

Sean Naughton – Piper Jaffray: I guess, just first question on the comp. John, I think you mentioned that it did get steadily better throughout the quarter. Any additional color you could give us there? Then I guess, on – were there any regional differences that you could potentially isolate in terms of where some of the transaction weakness was in the quarter?

John J. Mulligan – EVP and CFO: I think on the – sequentially, yeah, I mean, it improved month-to-month within the quarter. None of the quarters were negative, which compared to first quarter was significant progress. July was notably the strongest, but a portion of that certainly was attributable to that back-to-school week moving in from August last year. So we did see it strengthening. But I wouldn’t want to overplay that, and certainly a portion of it is attributable to the calendar. Geography wise, we have not seen anything meaningfully different in aggregate across the quarter. In any one week or day, there is differences depending on when back-to-school starts in various portions of the country, but nothing meaningful across the country.

Sean Naughton – Piper Jaffray: Then I guess you talked about some lower advertised prices in the circular. Is this really just in Canada or is it also in the U.S.? And is that some of the gross margin pressure that you’re thinking about in the second half as you’ve done a very nice job in terms of a rate improvements in between categories over the last , call it four or five quarters here?

Gregg W. Steinhafel – Chairman, President and CEO: Well, I would say – this is Gregg, in the U.S., we continue to offer hot pricing. There isn’t going to be a meaningful change in our strategy, because day-in and day-out, we have unbeatable prices. When you take a look at our – the fact that our prices are competitive, the price match policy both online and in-store and our REDcard’s performance day-in and day-out, we have a very strong value proposition. And our circular pricing is even more aggressive than that, and we take market-leading positions. In Canada, we know that we have an opportunity to break those shopping habits and we’ve got to focus on driving need-based trips. So there, in particular, we will sharpen up our pricing and make sure that we’re taking a more of a market leader position. Our REDcard penetration is still very, very small there, and we expect that to grow over time. But it’s more in Canada that we’re going to make sure that our prices get more noticed than they have been up to this point. A part of that was a conscious plan on our part to make sure that we really won in home and apparel and we feel real good about where we are in those two businesses today, so we’re proud of that fact. Now we have to just turn on the gas a little bit on the other side of the equation to make sure that we’re getting the Canadian guests to understand what great values we offer on frequency categories and break some of those well-established habits…

Sean Naughton – Piper Jaffray: Then just real quick, on the dilution in Canada, obviously, up quite a bit here in 2013 from the initial expectation. Any way or ability to paint us a picture; I know you still remain confident in that five-year outlook on the progression towards that $0.80 in 2017?

John J. Mulligan – EVP and CFO: So, I’m not entirely clearly what you want; is it that, why are we confident about the $0.80 or what will we see happen here as we go forward, Sean?

Sean Naughton – Piper Jaffray: Yeah. So, I guess the question is, is there any ability to say that the Canadian business will be – you believe the Canadian business may be accretive in 2014?

John J. Mulligan – EVP and CFO: So, on 2014, I think very early here. And we’ve given you our best view. I think when you step back we’ve been operating 60-some stores for on average about 2.5 (commodities), and so, we’re giving you our best information here for 2013, and clearly sales are a little bit short of where we need to work through some of the inventory and optimizing the business and optimizing our expense structure. I think as we look forward getting the other 56 stores open getting to the holiday; we’ll certainly provide a lot more information about where we expect to be. But in 2014, I think we expect to see meaningful improvement in the profitability of Canada, we’ll cycle-past all the start-up expenses, we’ll have our inventories more in line with sales patterns that we now have some information on. Our expense structure will be optimized to the sales level and we’ll start to grow sales. So I think we’ll see meaningful improvement in 2014, but I would say probably from this perspective today unlikely that we’ll see profitability on the full year and we’ll be back to provide a little bit more information on what that looks like and the cadence throughout the quarters again as we get a little bit more information this year to get the stores open, get new markets and get to a holiday season most importantly.

 

Incremental Canadian Dilution

Greg Melich – ISI Group: I want to follow up on Canada and touch on the U.S. Just to make sure I got that right or maybe ask in a different way, John, if you look at the incremental Canadian dilution this year, how much of it is related to those items of clearance and how much of it would be related to, if you will, start-up costs or advertise and how much of it do you think is just a different margin structure in the business to drive that frequency in trips?

Gregg W. Steinhafel – Chairman, President and CEO: Yeah, I think parsing that all out is difficult. I would say the second one, incremental marketing and advertising is not material to the total move from where we were to where we are today. I think the biggest driver of the change in profitability or dilution this year comes from, we had a set of sales expectations as we entered in the market and we also – given all the excitement that we saw building over two years, we protected on the upside from an expense standpoint and from an inventory standpoint, and the sales have been somewhat disappointing. And so, we had to work through those inventories, there is some clearance activity, there was some excess inventory this quarter as well that we’ve worked through and we need to right size the entire expense structure for what – for the sales numbers that are currently – that we’re currently operating at. So I think that’s the vast majority of it. I don’t think we see – I know we don’t see going forward a change in the overall – our view of what the margin rates were going to be, EBITDA or EBIT rates were going to be in Canada over the long-term. We feel very good about gross margin, and frankly, we expect gross margin will deteriorate a little bit as we begin to drive these frequency categories. You don’t see that in this quarter’s results because there was a fair bit of clearance in excess inventory that we moved through, but we expect margin rates will come down as we grow sales in those frequency categories but net, net, that’ll be good for the business and start to apply leverage against the fixed expenses that we’ve built for the business.

Greg Melich – ISI Group: Then second, turning to the U.S., Kathee, it was helpful to go through all the initiatives you have, and – yeah, but it seems like the issue that is bigger than anything is traffic staying negative versus what you guys would’ve probably hoped for or expected a year or two ago. If we think about the traffic side of it more specifically, what in the back half do you think is going to help stabilize and improve that traffic trend? Or is it just the way it is now – the trip consolidation and that’s the way the consumer is, and if we’re going to get comp, it needs to be with more items and top line?

Kathryn A. Tesija – EVP, Merchandising and Supply Chain: Yeah, you’re right Greg; traffic was our issue. I do think that somewhat that is the way it is right now. We’re seeing a lot of trip consolidation across all guests. I think the part that I’m pleased about is that, when you look at our basket, we are seeing that they are buying more units from Target as well as increased selling price and they are trading up into higher price point products. So that’s great. I think as we move forward, the thing that we’re focused on in driving traffic is really making sure that as they are consolidating and they are doing more in one store, that we’re offering that compelling value, and Gregg talked a lot about all of those components but that we make sure that that continues to be rock solid as well as the innovative product, and I mentioned a lot of those that we have coming like Phillip and Haggar. In our seasonal categories, we’ve got a lot of new stuff coming. So that’s key. Then I guess the third thing that I would add is just making sure that our in-store experience remains outstanding, because we want them to be pleased when they come and continue to consolidate their trip and to do more at Target. So, we have great service every day, but in addition to that, some of the new things that we’re doing with flexible fulfillment like buy online, pick up-in-store, I think, will be fantastic in the back half. Then, we are also looking at really upping the in-store experience in key categories like beauty and the test that I described in baby. So, it’s a combination of those three things.

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