Inside Target’s Canadian Invasion

Target Corp. (NYSE: TGT), America’s second-biggest retailer by sales, behind Wal-Mart Stores (NYSE:WMT), has begun opening stores in Canada. The move marks the company’s first expansion outside the U.S.

The company opened its first three stores, in the province of Ontario, on March 5 and began welcoming shoppers at 21 more on March 19 and 28. It has also opened three distribution centers in the country and plans to open 124 Canadian outlets by the end of 2013. By the end of the decade, Target expects to have 200 Canadian stores open, generating total sales of about $6 billion a year.

To put these figures in context, Target, which operates 1,784 stores in the U.S., reported total revenue of $73.3 billion in its 2012 fiscal year, which ended February 2. That was up 4.9% from $69.9 billion in fiscal 2011. Net income increased 2.4%, to $3.0 billion from $2.93 billion. Earnings per share gained 5.6%, to $4.52 from $4.28, due to fewer shares outstanding.

Target first revealed its Canadian expansion plans in January 2011, when it announced that it had agreed to purchase the leases of 220 sites that were occupied by the Zellers chain for $1.825 billion Canadian (1 Canadian dollar = $0.99 U.S.). At the time, the company estimated that remodeling these locations would cost about $1 billion Canadian. In 2012, Target spent $932 million on the expansion, including the new stores and distribution centers, according to its 2012 annual report.

Canadian Pricing Strategy Will Be Key

The move makes sense as Target’s first step outside the U.S. About 70% of Canadians are familiar with the company’s brand, and about 30,000 of them already have a Target U.S. credit card.

Target has said that it is happy with Canadians’ response to the new stores so far. However, some analysts have raised concerns that shoppers may view the chain’s prices as too high compared to the competition.

“After a strong opening for Target Canada, our checks suggest traffic has slowed below expectations in recent weeks, driven partly by Canadians’ perception that prices are too high, both relative to Wal-Mart and Target’s U.S. locations,” wrote Deutsche Bank retail analyst Paul Trussell in a research note quoted by the Financial Post. “While shoppers appreciate the higher quality assortment, especially in discretionary categories, the complaints on pricing were alarming.”

Canadian shoppers have long complained about products being more expensive in Canada than in the U.S., particularly in recent years, when the Canadian dollar has been trading near parity with the greenback. The Conservative federal government has also been paying attention to the issue. In his latest budget, Finance Minister Jim Flaherty eliminated $76 million of tariffs on certain goods entering the country, including baby clothing and ice skates, mainly to address this price gap.

“This is an important test. We’re going to take a few items . . . take the tariffs off them, and we’re going to see what happens to prices in Canada,” said Flaherty in a March 21 Toronto Star article. “We’ll see if we see an actual reduction in prices [and] we see tariff savings flow through to Canadian consumers.”

A Snapshot of the Canadian Retail Market

The Canadian retail market is already hotly competitive. Target is going up against a number of other U.S. chains that have established themselves in the country, including Wal-Mart and Costco Wholesale (NasdaqGS: COST). However, some of the stiffest competition may come from Canadian domestic retailers, many of which command strong customer loyalty and have been cutting costs and revamping their stores in anticipation of Target’s arrival. Here’s a look at three:

1.     Canadian Tire Corp. (TSX: CTC.A), is an iconic Canadian retailer that traces its history back to 1922. It sells a wide range of goods, from hardware to sporting goods and household appliances, at its 490 Canadian Tire stores across the country.

The company also operates the 386-store Mark’s chain, which is Canada’s largest seller of men’s clothing and footwear and also offers a growing number of women’s clothes; and FGL Sports, which sells sporting goods and outdoor gear through 495 stores that operate under a number of banners, including Atmosphere, National Sports and Sport Chek. Roughly 90% of Canadians live near one of Canadian Tire’s stores.

As a February article in Canada’s Globe and Mail newspaper points out, Canadian Tire isn’t as direct a competitor to Target as, say Wal-Mart, but it will present a challenge in the clothing (mainly through Mark’s) and small-appliance segments.

2.      Loblaw Companies (TSX: L) operates as Canada’s largest chain of grocery stores, with 1,053 locations across the country. It also sells drugs, footwear and clothing, including the Joe Fresh line—which is currently sold in J.C. Penney (NYSE: JCP) stores in the U.S.—as well as household goods. Aside from Loblaws, its brands include No Frills, Real Canadian Superstore, Fortinos and T&T (which specializes in Asian foods).

Target will compete with Loblaw for sales of general merchandise and drugs. Some of the new Target stores also offer groceries. Over 90% of Target’s new outlets will be near a Loblaws location.

3.     Shoppers Drug Mart (TSX: SC) is Canada’s largest drugstore chain. It sells prescription and over-the-counter drugs, personal care and household products at over 1,240 outlets operating under the Shoppers Drug Mart and Pharmaprix (in Quebec) banners.

“The great advantage that Shoppers has is a stunning amount of built-in traffic to its stores, partly for the prescription counter,” CIBC World Markets retail analyst Perry Caicco recently told The Globe and Mail.

The company will compete with Target in a number of segments in addition to drugs. In response to the tightening Canadian retail environment, Shoppers has recently been adding to its offerings of beauty products. In November, it opened a new, 4,000-square-foot prototype in-store boutique at one of its Toronto stores. The new boutique is much larger than the 2,500-square-foot boutiques in its other outlets and carries more upscale brands, like Chanel and YSL.