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Target’s Q4 Net Profit Plunged 46%; Canadian Expansion a Disaster

Target, the second-largest discount retailer in the U.S., reported its fourth-quarter earnings which exceeded some expectations and disappointed others.

Net income declined 5.2% to $981 million, down from $1.04 billion from last year. Profit totaled $1.49 per share; analysts were generally forecasting $1.39. Target’s stock rose 2.9% on the strength of the news; last year its shares dropped 15 percent.

Chief Executive Officer Gregg Steinhafel has held sales steady by improving the stores’ selection of perishable produce and offering steep discounts to shoppers who use either company-issued credit cards or gift cards. He said:

“For more than 50 years Target has succeeded by focusing on our guests. 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 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.”

Some experts are interpreting the fourth-quarter results optimistically, as a portent of Target’s recovery from recent troubles. Speaking to Bloomberg, Matt Arnold, an analyst at Edward Jones & Co., said, “They have sustainable growth in front of them.”

However, Target’s performance still presented causes for concern. Overall earnings before interest expenses and income taxes declined 22.4%, from $1.82 million to $1.43 million. Sales dipped 6.6% from $20.9 billion to $22.4 billion, a 2.5% decrease in comp-store sales. Even more ominous, net profits skid 46 percent to $520 million, down from $962 million.

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Target continues to struggle with its gross margins, which contracted for the sixth successive quarter. For the fourth quarter, gross margins narrowed 0.3% to 28.4%. Analysts largely predicted 28.8%.

Also, these numbers do not reflect the losses Target anticipates as a result of its much-publicized security breach. Hackers broke through Target’s online security system, accessing the personal data–financial and otherwise–of more than seventy million shoppers. The credit and debit card information of more than forty million people is now considered compromised.

Analysts predict that at least 15 percent of the credit cards could incur fraudulent charges, averaging as much as a few hundred dollars in illicit charges per card. The debacle could ultimately cost Target several billion dollars in total, with an estimated $1.1 billion in repayments to banks for unauthorized transactions.

Also, adding to these costs will be expenses associated with impending litigation. Currently, there are nearly seventy-class actions suits alleging that it failed to take adequate steps to ensure the safety of its customers. Tina Wolfson, an attorney at Ahdoot & Wolfson P.C., who is the lead attorney on one of the suits, said that Target’s failure “to maintain reasonable security procedures, and delays in notifying customers, will put her clients at risk for identity theft for years.” She continued, “This could be the biggest case I’ve seen in number of people affected.”

For the full year 2013, Target’s sales declined 0.9% to $71.3 billion, down from $72 billion last year. For the same period, net profits dropped a substantial 34.3%.

Target’s fourth-quarter report also doesn’t fully reveal the extent of its missteps regarding its attempt to expand further into Canada. Target originally had grand ambitions about the potential for the move but ultimately lost more than $800 million so far making the attempt.

Target’s strategy was beset by problems from the very beginning. Many experts believe it was unwise for the retailer to hastily launch 124 news stores into an untested market within only a few months. Also, Target has suffered from severe inventory problems, failing to keep is stores adequately adequately supplied in a timely manner. Elizabeth Evans, the associate dean of the Ted Rogers School of Management at Ryerson University in Toronto, speaking to the New York Times, said, “Target took on a very big challenge. Most foreign retailers launch with a smaller number of stores. Here you’re talking about a company that basically opened up 124 stores with a new management team and no history in the country.”

Nevertheless, most analysts believe the crux of Target’s miscalculations is a failure to satisfactorily understand the Canadian consumer, hardly a simple duplicate of his American counterpart. Many Canadian shoppers complained that quality of the apparel at Target was inferior to the apparel they experienced in the U.S. stores, and that many of the brands carried in the U.S. stores were absent from the Canadian ones. Also, they complained that the prices in the Canadian Target were too high. And though Target intends to eventually offer discount Canadian brands that have proven popular in the country, like Beaver Canoe and Roots athletic wear, their addition to its product lines has been plagued by delays.

The Canadian consumer also approaches shopping at major retail destinations differently from the U.S. consumer, opting to selectively patronize several different stores rather than choose one-stop shopping. For example, a Canadian shopper will buy meat from one store and socks from another, hopping from store to store depending on the product. Unlike the American consumer who cultivates a sense of loyalty to a store, Canadians generally develop loyalty to specific brands, irrespective of what store offers them.

Jim Danahy, the chief executive of CustomerLAB, a retail consulting firm, explained the gravity of Target’s mistake. “They have been potentially fatal in the their assumptions about the market and you could go one step further and call it arrogant. That’s a concept Canadians do not have culturally as even the mighty Walmart has found. They’re going to have to take a different tack.”

Target also seems to be suffering from inefficiencies in its supply chain. The retailer’s management failed to account for a regulatory divide that separates business in Canada from business in the U.S., overlooking the vast differences between the two countries in terms of tariffs on food and packaging laws, often preventing the Canadian stores from being supplied by Target’s distribution network in the U.S.

Some experts have suggested that Target’s security breach actually obscures the full extent of its troubles, since so many have reflexively attributed their slumping sales to the public relations debacle. Rob Wilson, a retail analyst at the Tiburon Research Group, said, “The data breach seems to have come at a good time for them as they would have been answering questions about this. I’ve never seen a set of expectations that are so shockingly missed on a rollout.”