How Is Target's Groceries Business Evolving?

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Target ( TGT ) is one of the biggest retailers in the U.S. and offers a variety of products such as hardlines, apparel & accessories, household essentials, home furnishing, and foot & pet supplies. However, it still trails its competitors in groceries, which is an essential product category due to its high degree of immunity to macroeconomic fluctuations. Although the company began its operations in the 1960s, it did not introduce groceries until 1995.

The share of groceries in Target's overall revenues, although still low, has grown steadily over the past few years due to enhanced focus and the launch of P-Fresh store remodel program. We believe that the figure will continue to rise with the expansion of CityTarget stores (more groceries) and grocery-centered marketing campaigns. However, the company may find it difficult to match the prices of Wal-Mart, the largest and the cheapest grocer in the country. Besides Wal-Mart's smaller format stores, Target will have to compete against a strong network of dollar stores in urban areas.

See our complete analysis for Target

Why Are Groceries Important?

Consumer spending on groceries can be classified as non-discretionary as they fall under people's basic necessities. Grocery sales are less correlated to macroeconomic factors. This is evident from the fact that during the 2008-2009 recession, consumer spending on food and beverages remained more or less stable, according to economic data provided by the Bureau of Economic Analyis (BEA).

Groceries are also important for the retailers because customers are 10 times more likely to visit a grocery store than a pharmacy or a general retail store. This improves cross sell and increases the overall basket size for the retailers. For instance, Target stores with partial-line groceries in them had higher overall sales than stores without them. There is no doubt that groceries are an indispensable product category for big retailers such as Target and Wal-Mart.

How Has Target's Grocery Business Evolved?

About 15-20 years ago, Target was not known for grocery items as it offered only a few products such as milk, chips and Hot Pockets. However, with the success of Wal-Mart's Supercenters, the retailer also started adding groceries to its aisles as it opened its first Super Target store in 1995. This store included a grocery section with fresh produce, dairy and meat. Same year, the company also launched an exclusive line of groceries under the name "Archer Farms" which offered staples such as bread, milk, pasta and bottled water.

As groceries were never the primary focus for Target, the category's share in the company's overall revenues has remained low. However, there has been some progress in the recent years as the company realized the importance of this product category and started making some efforts on this front. Back in 2009, groceries contributed about 16% to Target's overall revenues. The figure steadily increased to 20% by 2012, and stood at 21% for the first half of 2013.

What Is Target Doing For Its Grocery Business?

Target launched its "P-Fresh" store remodel program in 2009 aimed at expanding its groceries business. P-Fresh is an expanded fresh food layout located in a highly visible location within Target's stores which displays frozen and dairy products, perishable items, snacks, beverages and other grocery items. With this layout, the grocery offerings in the stores went up by about 40%. Additionally, it led to an increase of 90% in the food category and 60% in SKUs available at the stores. (( Target To Expand P-Fresh To 350 Stores in 2010 , Supermarket News, Nov 18 2009)) This format was successful as it boosted Target's comparable store sales growth and revenues from groceries in 2011. In the beginning of 2013, about 1,100 Target stores had the P-Fresh food section and about 250 stores had a full line of grocery items.

Target is looking to promote itself as a grocery retailer with appealing and unconventional marketing campaigns. The retailer launched a few ads earlier this year that tried to associate its groceries with fashion and glamor. For instance, one of the ads features a model standing besides cake mix boxes and blueberry muffins exploding in different colors. Also, the retailer is expanding its smaller format CityTarget stores in densely populated urban areas to continue its expansion in the U.S. and compete with dollar stores. Since dollar stores mainly offer grocery products at discounted prices, Target will have to add more grocery items to its smaller format stores in order to stay competitive.

What Threats Does Target Face?

The main threat that Target faces for its grocery business is competition from Wal-Mart. The retail giant earns about 55% of its revenues from groceries and is the biggest grocer in the U.S. It will not be easy for Target to attract customers as its products are slightly expensive than Wal-Mart's. According to a semi-annual pricing study by Kantar Retail, a basket of goods at Wal-Mart was about 4% cheaper than a similar basket at Target. Target relies on specific and occasional discounts rather than providing low prices everyday, which makes it difficult for the retailer to compete with Wal-Mart.

Moreover, Target's CityTarget stores are expanding slowly while Wal-Mart is aggressively opening its smaller format Express stores. In the last two years, Target has only opened 7 CityTarget stores compared to 76 small format stores opened by Wal-Mart. The company may need to ramp up its expansion. Apart from Wal-Mart, it faces stiff competition from dollar stores. These stores are essentially very small discount stores that are conveniently located in low income neighborhoods. With aggressive expansion, dollar stores such as Family Dollar, Dollar Tree, and Dollar General have taken away some share in the groceries market from traditional grocery stores and drug stores.

Our price estimate for Target stands at $76 , implying a premium of near 20% to the market price.

Understand How a Company's Products Impact its Stock Price at Trefis

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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