Investor Shock Behind Target Earnings, Shift In Business Model Is Unwarranted, Expert Says

When Target Corp. announced it will lower prices and push further into urban metros with the continued development of its smaller store format, Wall Street investors responded in an uproar. The retailer’s shares dropped 14%, its largest intraday fall since the Great Recession. But was the response warranted?

It did not help matters that Target announced this major three-year repositioning plan, which will run up a tab of $7B, while on a conference call to discuss disappointing Q4 earnings. Both profits and same-store sales missed analyst estimates for the quarter as consumers continued to flock to e-commerce. Stocks ended the day at an eight-year low as investors balked at the idea of Target lowering its prices to compete better with Walmart.

“This combination of changing behaviors and expectation, it is certainly causing stress in our model. But the reality is this is where the guest wants to be," Target chief executive Brian Cornell said during the earnings call. "We will never be successful if we dig in and insist they shop the way their parents did."

Garrick Brown, Cushman & Wakefield national retail research director said Wall Street’s response was a broad overreaction based on fear of the state of the retail industry as a whole.

“It’s your typical Wall Street painting all of retail with the same brush,” Brown said. “What they’re not getting is the stores Target wants to open are all smaller format, urban and based on personal needs retail.”

A similar occurrence has been plaguing publicly traded retail REITs. Department stores like Sears, Macy's and J.C. Penney are shuttering and consolidating stores, but other portions of the retail industry are strong. Major REIT landlords are healthy but struggling to squash the perception that problems plaguing some retailers automatically spell trouble for the entire industry.

Urban Expansion

This is not the first time Target has presented these plans. Last year the retailer opened 32 smaller format stores, averaging about 20k SF, in urban neighborhoods and on college campuses in California and New York, specifically within San Francisco, Tribeca, downtown Brooklyn, Forest Hills and Queens. Sales within these smaller, cheaper options outperformed sales in the company’s traditional 100k SF stores, according to chief financial officer John Mulligan.

“These sites are unlocking tremendous value. They have more than two times the sales productivity of our average store. So even with higher operating costs they generate healthy returns,” Mulligan said during the earnings call.

Target will roll out 30 of these smaller stores this year, and anticipates opening an additional 40 by 2019, focusing on Chicago, Los Angeles and New York. The goal is to better appeal to Millennials' needs by providing basic necessities and expanding into markets where the young professionals are most dominant.

“Most of the urban locations are [seeing] very strong sales and frankly, what’s happening is the closures happening are being driven by the apparel and department store categories that are seeing a ton of encroachment from e-commerce,” Brown said. “If you look at personal needs-type retail, grocery stores [and] drugstores, that segment is not feeling this; if there are drugstore closures it has to do more with merger activity, not weakness in the sector.”