• Andrea Lillo

Target outlook okay say industry analysts

Analysts came away from their annual meeting with Target execs late last month feeling generally favorable about the company, although some see challenges ahead for certain parts of the business.

While analysts said the meeting yielded nothing new, post-meeting interviews and reports point to three areas of scrutiny: the accelerated rollout of a supercenter format that hasn't perfected its profit formula, the continued vulnerability of Mervyn's to Kohl's 2003 entry into California, and longer-term concerns about how heavily Target will rely on its growing credit business.

Management didn't directly address sagging same-store sales at the meeting, analysts said, though most agreed that the results were mainly due to the economy.

"They will do as well as anyone else" in this economy, said Wayne Hood, Prudential Securities, who noted that even Kohl's numbers were declining.

"They continue to focus on a value message," said Deborah Weinswig, Salomon Smith Barney. She noted that the numbers have been sluggish due to Target's high percentage of apparel, a category that has not done well recently.

SuperTarget is becoming a more important component of Target Corp., and management has said it expects 25 percent to 40 percent of its annual square footage growth to come from SuperTarget expansion, though analysts said that this area is still under development.

"SuperTarget was never as important to Target as the supercenters are to Wal-Mart," said Bill Dreher, WR Hambrecht. "We're not fully convinced that the 'cheap chic,' 'class for the masses' concept that Target pushes is fully transferable to the food and drug side."

Wal-Mart already does an effective job emulating a good, basic everyday low price grocery, Dreher added. For Target, it's a matter of how it will differentiate itself, he said. Does Target head down the organic food route or become an upscale gourmet emporium? "I think not," he said.

It's difficult to bring fashion and color to the food area, he added. "SuperTarget is still a work in progress. They've made dramatic improvement over the years."

Weinswig agreed that it's a difficult category to distinguish. "Food is a commodity item," she said, and Target is being careful to remain competitive with Wal-Mart on pricing. It also has added branded food programs from Krispy Kreme and Einstein's Bagels to distinguish itself. And unlike Wal-Mart, Target is using food to drive traffic to the other side, she said.

Approximately 80 percent of SuperTarget sales are generated from products carried in traditional Target discount stores, according to a post-show report from Lehman Brothers.

More troublesome is the supercenter format's productivity. Although supercenters ring up 50 percent to 100 percent more sales than Target discount stores, their ROI is not any higher, analysts said.

"What you worry about is that … it's tough even for groceries," said Hood, noting the recent performances of Albertson's and Kroger. However, Hood felt that Target's plan for its SuperTargets was "controlled and methodical; they don't need to be the largest super grocery chain."

Several analysts were less sanguine about Mervyn's prospects as Kohl's readies itself for entry into the Southern California market in 2003. Target told analysts it will remodel 75 percent of the store base within three years, though few details were provided. Management did say that Mervyn's will emphasize national brands — a strategy that UBS Warburg characterized in its post-meeting report as "an undifferentiated strategy from [Kohl's] without the execution excellence and real estate advantage."

Mervyn's has had seven out of 10 years of flat or negative same-store sales, noted Dreher, so while remodeling is a step in the right direction, "it might be too little too late. Customers' perceptions won't turn on a dime."

In WR Hambrecht's report of the meeting, Dreher noted that Mervyn's has already added a number of national brands and will be implementing better inventory controls to reduce clearance markdowns, "something Kohl's has been a master at for years."

The report added, "While we are pleased with Mervyn's attempt to emulate many of Kohl's best practices, we believe Mervyn's must be more innovative to take the lead — just as a sailor cannot win a race by following the leader." The report also stated that the firm would like to see Mervyn's develop brands on a similar level to Target Stores' creative merchandising.

Hood said he didn't believe the remodels would be a big capital investment. "You don't want to put your money into a store base which continues to decline; you want to make sure it's a viable operation."

Weinswig said she recently visited the Southern California market and thought that some of the stores up for remodeling already looked satisfactory. Mervyn's "is such a small part of the corporation" that the impact on sales may be a penny on the bottom line, she said.

Hood estimated that Kohl's may impact Mervyn's comps by as much as a point.

On the heels of Sears' credit problems last month, Target's Smart card Visa program was also discussed, but analysts were still comfortable with how Target was handling it.

Target acquired its Visa customers in a different fashion than Sears did their card holders, Weinswig pointed out, as Target focused on active card holders while Sears culled from dormant customers. The Visa portion of the credit card program is key for Target, she added, since that customer is more creditworthy than holders of Target's store card. However, the yields are lower. The program also gives Target the benefit of identifying what customers are buying at other retailers.

Target's card is also different from other programs as it doesn't include such "bells and whistles" as convenience checks or teaser rates, said Dreher.

But he felt at ease with the card's performance. "The Smart card receivables are not growing as quickly. When receivables grow, it's difficult to get a clear read. But Target is slowing down the growth, and that increases our level of comfort." He also pointed out that Target has a much higher reserve rate than Sears but needs to be watched as it is still a potential risk.

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