Target Summary of the Firm Target Is Essay

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Target

Summary of the Firm

Target is a general merchandise retailer that competes in the discount segment of the market. Target has stores in every state except Vermont, and next year the company will be expanding into Canada, adding 125 to 135 stores in that market. Including U.S. expansion, Target will grow around 10% in the next year. Target competes as a cost leader, pitting it against Walmart and K-Mart as direct competitors, and more broadly against other major retailers ranging from warehouse stores to department stores, discounters like Marshalls, or online retailers like Amazon. The key success factors for Target include operational excellence that allows it to remain price competitive, real estate selection, and the ability of Target to differentiate itself from other retail outlets.

Profitability

In the discount retailing industry, firms generally operate on a model that emphasizes delivering low costs to the customer. Thus, companies have very slim margins and profits are generated primarily through the cultivation of high volumes. Target's income statements over the past several years highlight this. In FY2012, the company recorded a gross margin of 30.8%, the same as the prior year. The company's operating margin is 6.4% and 6.7% in FY2011. The net margins for the past two years are 4.2% and 4.3% respectively. These figures highlight that Target's margins are consistent with what one would expect from a discount retailer. The slight differentiation that Target has allows it slightly higher margins overall, compared with some of the company's competitors. The other thing that these figures highlight is that Target has good control over both its pricing and its costs, for its margins to be so consistent at all levels over the course of two years.

The cash flow from operating activities is the key measure of a company's ability to generate cash. For the last year, target earned $5.4 billion in cash and $5.2 billion the year before. The cash flow from operating activities is generally significantly higher than the net income, because of the amount of the company's depreciation expense. Target's cash outlays are typically for a mix of capital expenditures, dividends and the retirement of stock (share buybacks). The company scaled back its capital expenditures during FY2009 and FY2010 in response to the economic slowdown, but the move into Canada has increased these again for the latest fiscal year.

Ratios

There are a number of ratios that can be used to help understand the financial condition of Target. Financial ratios include the liquidity ratios, profitability ratios, operating performance ratios and investment valuation ratios (Loth, 2012). The current ratio is a good measure of the company's liquidity. For FY2012 this was 1.15, compared with 1.71 the year previous and 1.62 in FY2010. The reason for this spike is that Target had $3.8 billion in long-term debt coming as the current portion of long-term debt on the past year's balance sheet. This increased the current liabilities. However, Target's current ratio is still above 1.0, meaning that it has the assets on hand to meet its pending financial obligations.

Another ratio, one that covers the long-run solvency of the company, is the debt-to-equity ratio. For Target this is 1.94 and the debt is a mix of long-term debt and current liabilities. This figure is relatively high, because the company must cover this debt out of its cash flows. However, Target has fairly steady cash flow from operations, and its business is not particularly volatile (beta 0.89). Thus overall Target has a fair amount of debt, could benefit from reducing it a little bit, but the debt burden is not so great that it is a major concern for the company. The debt/equity ratio was 1.82 in FY2011 and 1.90 in FY2010.

The price to book ratio reflects the market's impressions of Target. The current market cap of Target is $41.08 billion and the book value of the company's equity is (Q3 FY2013) $16.532 billion. This means a price to book ratio of 2.48. The annual report does not cover the stock price for the past years, but the P/B ratio was 3.28 at the end of FY2012 and 3.52 at the end of FY2011.

Another ratio is the return on assets. For Target this was 6.3% in FY2012, 6.7% in FY2011 and 5.6% in FY2010. This has fluctuated a little bit with the size of the asset base and the net income, but has remained rangebound for the entire three years. Target's business and its returns to shareholders have been quite stable over the past three years.

One asset utilization measure for Target is the inventory turnover ratio. This is important for general merchandisers for a few reasons. One is that a significant amount of the company's working capital is tied up in inventory, so the ability to convert that inventory to cash is important. Additionally, many items at Target are seasonal in nature, and therefore the company benefit from moving the out of the store quickly, before they decrease in value. The inventory turnover in FY2012 was 6.1, down from 6.13 in FY2011 and 6.34 in FY2010. These figures indicate a slight decline in the ability of Target to move out its inventory quickly, which is a negative trend for the company.

Another metric that can be considered is the fixed asset turnover, which is an operating performance ratio. This was 2.4 times in FY2012, which was down from 2.6 times in the two prior years. The reduction in fixed asset turnover reflects an increase in the plant, property and equipment by about $4 billion in the last fiscal year, probably a reflection of acquiring property in Canada.

Interestingly, it is not easy to compare Target with K-Mart, being that K-Mart is not a publicly traded company. K-Mart is owned by Sears Corporations, and the Sears financial statements reflect both the K-mart business and the Sears business, so it is not possible to filter out K-Mart's results specifically. What is revealed in the latest annual report from Sears is that Kmart had an adjusted EBITDA of $172 million in FY 2012, which was down from $508 the previous year and $364 the year before that. Same store sales declined 1.4% and that Kmart's gross margin declined 1.9% due to higher commodity costs and markdowns on goods.

Other key statistics for Kmart include a 22.7% gross margin, which is lower than that of Target and an operating loss of $34 million. That company had an operating profit of $353 million the year previous. In general, then, Target can be said to have better financial statistics than Kmart, simply by virtue of the fact that it is profitable and its business is growing.

Overall, Target has a healthy balance sheet and the risk level of the firm is low. The company is liquid and it is solvent, with a current ratio over 1.0 and the debt-equity ratio of 1.94. It might be better for Target to lower its degree of leverage a little bit, so it remains to be seen what it will do with the current portion of long-term debt that is due this year. If Target pays that off, it will bring its degree of leverage down to a healthier level. With interest rates as low as they are, however, Target will probably roll that debt over and finance further expansion.

The company has a fair degree of financial flexibility, in part because it has the current portion of debt. Having that come due gives the company the ability to either decrease its debt to equity ratio significantly or to maintain it at its present level. As noted above, we cannot actually tell how well Kmart manages its assets because Kmart is not a publicly traded company. We can assume that it is not managing its assets as well as Target…[continue]

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