Disappointing Canada sales drag down Target second quarter earnings

Initial euphoria over Target Corporation's expansion into Canada has given way to disappointing sales and prompted the retailer Tuesday to lower its profit forecast for the year.

With U.S. stores producing tepid growth, Target has embarked on the most ambitious expansion in its 50-year history — opening more than 120 stores in Canada by early next year. But as it announced quarterly earnings Tuesday, the Minneapolis-based retailer said its Canadian locations — more than 50 open so far — are struggling to sell seasonal goods and non-discretionary items like food and health care products.

CEO Gregg Steinhafel blamed the results on a nagging "price perception" held by shoppers in Canada. Although Target's apparel and home sections have done well, consumers believe Target's prices on non-discretionary products are higher than its rivals, he said.

"In Canada, we know that we have an opportunity to break those shopping habits and we have got to focus on driving need-based trips," Steinhafel told analysts during a conference call. "So, there in particular, we will sharpen up our pricing and make sure that we are taking a more of a market leader position. … We're going to make sure that our prices get more noticed than they have been up to this point."

While analysts say Target has plenty of time to succeed in Canada, investors were counting on Canadian consumers to fortify the company's overall performance given the still tentative American economy. But Canada's disappointing numbers alarmed Wall Street, prompting Target shares to fall 3.6 percent to close Tuesday at $65.50.

With U.S. sales still weak, Target's problems in Canada are "scaring people," said Brian Yarbrough, a retail analyst with Edward Jones Investments in St. Louis. "If you didn't have Canada, the stock would not have been down as much. It really took people by surprise."

The company now expects annual profits to be on the low end of its initial forecast of $4.70 to $4.90 per share. Target earned $611 million, or 95 cents per share, in the second quarter, compared with $704 million a year earlier.

The retailer also hasn't enjoyed a strong reputation for operational prowess.

Indeed, the first days of Target's entry were marred by widespread reports of empty shelves. Since then, the company has marked down excess inventory in warehouses.

But while the early showing in Canada has been lackluster, Target has time to correct its problems, said Amy Koo, an analyst with the Kantar Retail consulting firm in Boston.

"It's still early," Koo said. "Certainly the [weak sales] are a warning sign. But it's not the end of the road."

Still, Target's wobbly start in Canada comes at an inopportune time for the retailer. Sales in the United States remain sluggish as consumers opt to spend their dollars on big-ticket items like homes and cars instead of clothes and electronics, company officials say. While profits remain healthy, mostly due to cost control, sales at stores open for at least a year in the second quarter grew just 1.2 percent. For the year, Target expects annual comparable-store sales to rise just 1 percent, down from its previous estimate of 2 to 2.5 percent.

"We overinvested a bit," Mulligan told the Star Tribune in a brief phone interview. "It will take some time to work through that. We pushed profitability out for some bit of time." In many ways, Canada's issues are nothing new for Target, Mulligan said. Whenever Target opens a store in the United States, the company always estimates how the location will fare in five years, then works backward toward the first year.

While its five-year projections usually prove accurate, the first year tends to "get all over the place," Mulligan said. "There are wide ranges of differences."

However, no one notices when one store in the U.S. misses the mark its first year because the company is so large. But when Target opens 120 stores in Canada in one year, those 12-month misfires get plenty of attention, he said.

Mulligan said Target does not need to adjust its pricing in Canada but rather do a better job educating consumers about prices. For example, Kantar studies have shown Target's prices are comparable to its Canadian rivals but shoppers feel otherwise. Extra marketing and increased adoption of REDcard, which offers 5 percent discounts on each total purchase, will help, he said.

"The good news is that we come from a good place," Mulligan said. "Studies show our pricing is very competitive with the low-price leader. We will use of all of the quivers in our marketing bag. We need to tell our story better."