Target Warning Rings True: Q4 Was Meaningfully Weak

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Target (NYSE:TGT) warned investors that December’s data breach would hurt fourth-quarter results, and management was right. For the three-month period that included the consumer spending-heavy holiday season, the retailer’s net profit almost halved as a result of the massive data breach that affected tens of millions of customers. The company also warned that the fallout resulting from the incident could even hurt future profits. Yet Target did manage to top the profit expectations of Wall Street, a sign that the second-largest U.S. discount retailer has started to regain customer loyalty.

“For more than 50 years Target has succeeded by focusing on our guests,” Target CEO Gregg Steinhafel said in the earnings press release. “During the first half of the fourth quarter, our guest-focused holiday merchandising and marketing plans drove better-than-expected sales. However, results softened meaningfully following our December announcement of a data breach.”

As part of Steinhafel’s efforts to draw shoppers back into stores after it was revealed that hackers stole the personal data and credit card information of millions of customers, Target offered weekend of 10 percent discounts in December and a year of free credit monitoring. The chief executive believes those efforts have begun to pay off. “As we plan for the new fiscal year, we will continue to work tirelessly to win back the confidence of our guests and deliver irresistible merchandise and offers, and we are encouraged that sales trends have improved in recent weeks,” he said.

Still, comparable-store sales decreased 2.5 percent in the quarter, a drop the company attributed to the data breach and which impacted Target’s quarterly performance. Steinhafel predicted in early January that the retailer would experience “meaningfully weaker-than-expected sales” for the fourth quarter.

In the fourth quarter, net income declined 46 percent to $520 million, or 81 cents per share, from the $961 million, or $1.47 per share, reported in the year-ago quarter. Comparatively, analysts had projected earnings to amount to 79 cents per share. Target’s sales drop was much less pronounced than its earnings decrease: Fourth-quarter revenue declined 5.3 percent to $21.5 billion, a figure that matched expectations.

But the cost of the data breach was huge. Beyond taking “the wind out of Target’s sails — and unfortunately sales,” as Planet Retail research director Sandy Skrovan told Reuters, the retailer incurred a number of expenses to clean up the data breach. Including costs to investigate the incident and to offer identity theft services to customers, Target spent as much as $61 million. Insurers covered $44 million of that total, leaving the retailer with an expense of $17 million for the fourth quarter. Those figures do not take into account any potential claims from payment card networks for fraud losses.

Investors did not respond negatively to the “meaningfully” weak sales, as the softer results were expected. Furthermore, as UBS analyst Jason DeRise told Bloomberg, the data breach “is a serious situation, but one that we think Target should recover from.” Shares rose less than 1 percent to $57 in premarket trading after results were released Wednesday morning, and once the markets opened, shares rose as high as $58.51. However, Target’s stock has declined 11 percent this year through Tuesday, which compares to the 6.8 percent decline recorded by rival Wal-Mart (NYSE:WMT) and the 0.2 decrease posted by the Standard & Poor’s 500 Index in the same time period. In 2013, investors bid shares of Target up 8 percent.

For the full year, Target expects earnings of between $3.85 and $4.15 per share. The company began opening Canadian-based retail outlets last year, and Target has said those stores will be included in its adjusted earnings figures this quarter. On that accounting basis, which will exclude costs from the data breach, Target has predicted profit of between 60 cents and 75 cents per share.

The catalog of the retailer’s problems extend beyond the payment system hack. Target’s entry into Canada has not been smooth. A key problem is that Canadians who once shopped at Target stores across the U.S. border now find Canadian prices much higher. They do not shop at its stores for basic items like food and medicine, as do U.S. shoppers. Plus, local competitors have lowered the prices in order to retain customers. Target’s Canadian operations generated sales of $623 million in the fourth quarter but reduced earnings by 40 cents. For the full year, the segment lost $941 million before interest and taxes, which lowered 2013 profit by $1.13 per share.

Of course, the retailer is not reporting signs of consumer weakness, and that is a plus.

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