Target: Dogged by the Housing Slump

Target's (TGT) stock price— along with those of many other retailers—ticked up in January as investors bargain-shopped for stocks that will benefit early from a potential recovery. But they shouldn't grab so fast for the trendy discounter's shares. That's because there's one underappreciated factor that's likely to cause Target to lag the retail pack: its deep exposure to the housing mess.

Compared to rival Wal-Mart (WMT), Target sells twice the amount of home-related goods as the Bentonville, Ark., behemoth. Analysts say that exposure will be a drag on Target's results until home prices start to recover, a process that could take at least two years. "You need a housing recovery to see Target improve their business, home or otherwise," says analyst Dan Binder of Jefferies (JEF). "I don't think that's reflected in (Target's) stock price."

This places Target in a jam. It's borrowing from Wal-Mart's low-price message to try to boost sales of everyday items, like laundry detergent and paper towels. But there is little evidence the plan will work, while the retailer runs the risk of undermining its chic image that has helped it compete against Wal-Mart. "The fact that [home goods] were such a strong core and magnet department certainly had a powerful impact on customers and investors alike," says Chris Ohlinger of Service Industry Research Systems, Inc.

Mirroring the Housing Market

What a difference five years makes. In 2003, Wal-Mart's sales at stores open at least a year were trouncing Target's. But as the housing boom kicked into gear, the picture reversed. What Wall Street missed was just how dependent Target was on that rise. Some 20% of Target's sales are home-related, vs. just 9% at Wal-Mart. "The housing boom had a very large influence on the success of their stock," Ohlinger says. "If they lose that, it really hurts them."

In fact, Target's surge in same-store sales mirrored the booming housing market. Over the course of 2004-2005, the change in the average price of homes ballooned to around 15%. At the same time, sales at Target stores that had been open at least a year swelled to 7.3%. Comparable-store sales at Wal-Mart stores fell as much as 1.3%.

As home values have fallen by double-digit percentages across the U.S., things look very different today. In the fiscal 2009 fourth quarter ended January, comparable-store sales at Target dropped 5.9%; Wal-Mart's sales were up 1.6%.

Pushing a "Value" Message

During the housing boom, consumers awash in paper wealth flocked to Target and other stores, like Pier 1 Imports, Bombay Co., and Linens n' Things, to outfit their digs with home goods. Since the bubble burst, though, the market for such products has been decimated. At Target, sales of such goods at stores open at least a year are down more than 20%. At Pier 1, sales at stores open at least a year are down 17.8%. Bombay and Linens n' Things declared bankruptcy. "Everyone's home business was inflated," says Joan Storms of Wedbush Morgan Securities. "I think they all benefited."

To help fix the leak, Target has two strategies, but both are fraught with risk. New advertising focuses on a "value" message, as the company attempts to change consumers' perception that its products are too expensive. But there's danger that the company could damage its chic image and devolve into a Wal-Mart knockoff, alienating the younger, trendier customers who made the store successful. "I don't think they should take a path that would destroy the brand image of fashion, quality, and innovation," says Wayne Hood of BMO Capital Markets (BMO).

The company has also been stocking up on consumables in an attempt to drive traffic, a strategy it's tried for years, but customers aren't biting. Analysts say consumers aren't willing to accept Target as a grocer and the company can't compete with Wal-Mart in a price war. Besides, the company only has so much upside with consumables—they bring much lower margins—and Target counts on higher-margined goods to support its hefty advertising bills. The company spends 1.89% of revenue on advertising compared with Wal-Mart's 0.53%.

Housing Sales are the Real Barometer

Products that bring higher margins, especially home goods, are typically purchased on credit—more bad news for Target. Profits from its eponymous cards are down $167 million from last year and bad debt write-offs are hovering around 12%. "There's no doubt that this kind of adverse mix impact will be with us until the economy improves," Target Executive Vice-President and Chief Financial Officer Doug Scovanner recently told investors.

For too long, Wall Street has focused on the discretionary nature of Target's products. Lower sales in a hobbling economy and credit woes are easy to spot and easy to price, but investors should be paying attention to Target's real barometer: housing sales. "Assuming we've reached the bottom, I suspect it will take at least a year or two for them to completely recover," Holinger says.

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