Target sharply lowers 2Q profit outlook, announces $110M breach charge

Target Corp. got some of the bad news out of the way before its new CEO starts next week.

The Minneapolis-based retailer on Tuesday sharply lowered its second-quarter profit forecast, citing the deep promotions it has used to win back customers following last year's massive data breach.

Target also said investors should expect "essentially flat" sales in the May-to-July quarter as shoppers continued to curb spending. Meanwhile, its Canadian stores, which have been bleeding money since their big rollout there last year, had "softer-than-expected" sales.

The performance warning, which sent shares down 4 percent Tuesday, came out exactly a week before Brian Cornell, a former PepsiCo and Sam's Club executive, takes over as Target's new CEO. Then on Aug. 20, Target will release its full results for the quarter that just ended Saturday.

"It does not hurt the new CEO to have these items disclosed before he starts," said Amy Koo, an analyst with Kantar Retail. "It sets expectations a little more appropriately."

Analysts also managed to find some positive news in Target's announcement. The retailer said the $148 million in expenses related to the data breach accrued in the second quarter should cover the rest of the "vast majority" of breach-related claims, including those by payment card networks.

That brings Target's total breach-related expenses thus far to $235 million, about $90 million of which is expected to be picked up by insurance. While Target said the total cost could end up being higher, analysts seemed pleased that the number was not as bad as some originally expected.

Last year, hackers accessed Target's point-of-sale system and swiped financial and personal information from tens of millions of customers for about three weeks before the company, alerted by federal investigators, cut off the criminals.

The cybertheft scared off many shoppers. So Target has been stepping up its deals to draw customers back to its stores. But the deals cut into margins in the first quarter, too, with its profit plummeting 16 percent.

In May, interim CEO John Mulligan told investors Target would continue to lean on promotions to drive traffic back into the stores, but would be more selective. But analysts have noted that Target has continued to discount aggressively, and because of the deeper promotions, Target now expects adjusted earnings per share of  78 cents, well below its prior outlook of 85 cents to $1 per share.

"While the environment in both the U.S. and Canada continues to be challenging, and results aren't yet where they need to be, we are making progress in our efforts to drive U.S. traffic and sales, improve our Canadian operations and advance Target's digital transformation," Mulligan said in a statement.

But Target's challenges don't end at the data breach. It also includes heightened competition from online retailers and other formats such as dollar stores and drugstores, which have been luring customers away from big-box stores like Target.

David Strasser, an analyst with Janney Capital Markets, said Target's lowered forecast shows that Target needs to invest in pricing and to rebuild loyalty and drive more traffic to its stores.

"We humbly advised the new CEO to look at this issue closely to compete longer term," he wrote in a research note. "Mr. Cornell: the ball, figuratively speaking, is in your court."

While Target's challenges are somewhat unique, it is also struggling with the same head winds of cautious consumer spending many retailers can't seem to shake off.

"Wal-Mart has been flat or down for several quarters in a row," noted Jason Long, a retail consultant with Shift Marketing Group.

Last month, the National Retail Federation lowered its 2014 retail sales forecast for the year to 3.6 percent, down from 4.1 percent, after a slow first half of the year due in part to severe weather. But it says it expects sales to pick up in the second half of the year.

And then there's Canada, where Target lost nearly $1 billion last year. Target's disclosures on Tuesday about continuing struggles with that division began reigniting the debate about whether it should cut its losses and exit the northern market altogether.

"Weaker-than-expected results in Canada has unfortunately become the expectation," said Sean Naughton, an analyst with Piper Jaffray.

His firm estimates it will cost Target $1.2 billion to shut down the Canadian business, but it has not yet issued an opinion on whether Target should do that.

But Naughton said Target needs to start seeing improvements in Canada "very soon."

Everyone is anxious to hear what Cornell, the new CEO, has to say on the matter. He has been silent thus far, not granting interviews since he was named to the post last week.