Target's Grocery Business Growth Is Slow Despite Its Efforts

Target ( TGT ) is one of the biggest retailers in the U.S. and offers a variety of products across hardlines, apparel & accessories, household essentials, home furnishing and 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 has grown steadily over the past few years, driven by its enhanced focus and the launch of P-Fresh store remodel program. With the expansion of CityTarget and Target Express stores, the retailer's grocery share will likely increase in the future, albeit at a slow pace.

However, despite showing some progress, groceries are far from becoming a meaningful category for Target. The company earns less than one-fourth of its revenues from food & consumables, and has found it extremely hard to attract grocery buyers due to fierce competition from its cheaper counterpart, Wal-Mart ( WMT ). Although the "cheap chic" retailer is looking to expand its business in urban markets, Wal-Mart's aggressive foray in the grocery space along with the existing vast network of dollar stores, will create a tough environment for Target. Subsequently, we do not see any significant development in Target's grocery business in the foreseeable future.

Our price estimate for Target stands at $70 , implying a premium of over 20% to the market price. See our complete analysis for Target

Why Is The Grocery Business SoImportant?

Consumer spending on groceries can be classified as non-discretionary as they come under 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 Analysis (BEA). Also, groceries are a big market segment, accounting for annual sales of over $560 billion.

Groceries are also important for 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.

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 prominently visible location within a Target store, displaying frozen and dairy products, perishable items, snacks, beverages and other grocery items. The grocery offerings in the stores with the new layout 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. 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 full-line grocery items.

In addition to expanding its grocery segment, Target tried to promote itself as a grocery retailer through appealing and unconventional marketing campaigns. The retailer launched a few ads in 2013 representing groceries as fashionable and glamorous. 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. These stores offer products relevant to urban dwellers' basic needs, mainly including groceries. Target has recently developed another format called Target Express, which specifically focuses on groceries that have high selling frequencies.

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 with a grocery section in 1995. 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.

Since groceries were never the primary focus for Target, the category's share in the company's overall revenues has remained low. Although there has been some progress in the recent years with the company's stressing more importance to the product category, the business hasn't made any meaningful contribution. Back in 2009, groceries contributed about 16% to Target's overall revenues, which gradually increased to 21% in 2013. At this rate, the retailer might be able to take its grocery revenue share up to 24%-25% over the course of next four to five years, which will still remain significantly below Wal-Mart's share of 55%.

It must be noted that Target made a name for itself in the U.S. retail industry not by selling groceries but by offering affordable fashion products and household essentials. However, if the company wants to increase its revenues from the groceries business, it needs to push aggressively to achieve its goals. A marginal increase in revenue contribution will not do much good for the company.

What Has Troubled Target's Grocery Business?

The main drag on Target's grocery business growth has been the biggest grocer in the U.S., Wal-Mart. It hasn't been easy for Target to attract customers as its products are slightly more 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. Last year, Target opened just three CityTarget stores, compared to more than 100 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. Wal-Mart hasn't given Target much room for its grocery business growth in the big-box space and the smaller format arena isn't looking good either.

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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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