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2013 Annual Report Research Report

Andy Mack, John Renick, Josh Duncan, Jessica Birolini, Laura Herman, Marcie Pagel
Executive Summary
Target is an American discount retail company and the second largest retailer in the United
States. In 2013 revenues as well as net earnings decreased, largely due to a credit card breach
that cost Target millions to resolve while also deterring some customers from shopping there.
However, Target achieved several great things in 2013. Firstly, Target expanded into Canada,
opening 124 retail locations and 3 distribution centers. Target also opened 19 new locations in
the United States, achieving the expansionary quota the company sets each year. Secondly,
Target sold its entire credit card portfolio to TD, recognizing a gain of $391 million. Although
revenues and earnings decreased, Target has illustrated growth and is rightly deemed a top brand
in the United States.
In this report, Targets 2013 Annual Financial Report will be discussed in detail. Items
covered in this report will include: business analytics, financial policies and ratios, explanations
of revenues and expenses, and potential investments.

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Analysis and Discussion
Target was founded in 1902 and is headquartered in Minneapolis, Minnesota. Target sells a multitude
of products, including but not limited to household essentials, food, home dcor, apparel, and accessories.
In addition to its in-store sales, Target sells its merchandise through its website and offers credit and debit
cards to its frequent customers.
Target utilizes a differentiation strategy, charging a slight premium compared to other discount retailers
such as Walmart or Kmart. The company differentiates itself through advertising, more upscale stores,
and more trendy merchandise. Target pays around 2% of its revenue on advertising compared to
Walmarts .4%. Targets advertising campaigns have been especially effective with around 96% of
Americans recognizing the logo. Because of this differentiation, Targets customer demographic is much
different from other discount retailers. Targets customers have a median household income of $60,000
and more than half have received a college degree. Target has created a niche for itself as the primary
upscale discount retail store in the industry.
Targets differentiation strategy in the discount retail industry is potentially dangerous for the firm in
the long run. While it has helped the firm to carve out a niche for itself in the industry, it was also
detrimental for the firm during the 2008 financial crisis when customers switched to lower cost retailers
like Walmart and Kmart. There is also potential future risk as Walmart has been attempting to move its
brand upwards to incorporate a degree of differentiation into its current cost-leadership strategy. If
Walmart decides to move upwards in the market it will cannibalize Targets market (Q1).
The 2013 Targets financial statements were audited by Ernst & Young LLP. These audits were done
in compliance with the measures that are set forth by the Public Company Accounting Oversight Board,
which is the controlling board for the United States. By all measures, Ernst & Young LLP believes that
Target gave a fair representation of their consolidated financial position, based on the United States
generally accepted accounting principles. Ernst & Young LLP is also responsible for conducting an audit
to determine if Target has a sufficient level of internal control over their financial reporting. They found

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no evidence of ineffective internal control; Target meet the requirements of the Committee of Sponsoring
Organizations of the Treadway Commissions criteria laid out in the 1992 Framework (Q2).
Revenue, Expenses, and Profit
Targets revenue recognition policy deals with the sales in store, where the customer gets their
purchase right away, as well as online orders, where the customers purchase must be shipped and
delivered. When a sale of merchandise is made in-store, the revenue is then recognized immediately at
the point of sale. However, when a consumer purchases something online, the revenue is not recognized
until the product is delivered. Part of the reason for this is that Target can generate shipping revenue.
They also use the historical return patterns in order to estimate expected returns, and they record their
revenues net of these expected returns (Q3).
Targets changes of revenue, expenses, and profit are split between the United States and Canadian
segments. Targets sales increased by $636 million or 0.9%. The segments total change in expenses is an
increase of $1,838 million (Cost of Sales: +$529 million, Selling, General, and Administrative Expenses:
+$1,164 million, and Depreciation and Amortization: +-$82 million). Thus, the segments Earnings
before Income Taxes decreased by $1,202 million from 2012 to 2013. A large factor that deterred their
profitability was the data breach that happened in their fourth quarter where an intruder stole payment
card data. Target incurred after-tax net expenses of $11 million; this includes their initial expense and the
insurance reimbursement. This data breach also decreased their revenue since customers worried their
information would be stolen. The Canadian segment

Figure 2: Changes in Sales, Expenses, and Profits

opened in 2013 with 124 stores throughout the country

so their sales and cost of sales increased dramatically
which drove up Targets total sales and expenses. In the
future, Target expects to see substantial investigation,

legal, and professional expenses and capital investments of chip-enabled smart card technology in regards
to the data breach, which may decrease their profit in future periods (Q7).

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Assets
For Target, buildings are clearly the most important long-term assets that are subjected to depreciation.
Buildings make up nearly 70 percent of total assets, indicating the importance. For property and
equipment, Target uses straight-line depreciation over the estimated useful life or lease term if shorter.
For depreciation and capital lease amortization expense in the years 2013, 2012 and 2011 respectively
was $2,198 million, $2,120 million and $2,107 million. For income tax expense, accelerated depreciation
is normally used. Target discloses rough estimates of their estimated useful life stating that, buildings and
improvements have 8-39 years of useful life, fixtures and equipment have 2-15 years of useful life, and
computer hardware and software have 2-7 years of useful life. These estimates seem reasonable on some
measure, but the grouping makes it difficult to determine actually amounts (Q6).
Inventory is incredibly important to Target. Their inventory reflects how well they have done in the
year, how much they still have and how much they have sold. Targets inventory is accounted for under
the retail inventory accounting method using last-in, first-out inventory pools. Target applies a cost-toretail ratio to all merchandise inventory pools ending retail value. Their inventory procedure practices
lower of cost or market. They estimate their losses to historical losses and clearance. Target strictly
manages their inventory in order to account for these losses properly (Q5).
Ratios
In 2013, Targets accounts receivable, credit card, posed an important issue. Receivables made up a
little over 12 percent of total assets. As of March 2013 Target sold its entire credit card portfolio to TD
for a gain of 391 million. So, as of that date, Target does not report receivables on their balance sheet,
making 2013 and 2012 incomparable. Further, turnover ratio was higher last year because Target has
ceased to collect credit card receivables in 2013 (Q4).

Figure 1: Receivables

The current ratio denotes of the ratio of current assets to current liabilities. The ratio is used to
illustrate the companys ability to pay its short term liabilities, including debt and payables. Using the
balance sheets as of February 1st, 2014 and February 2nd, 2013, the current ratio for 2013 is calculated as
11,573/12,777 = .906 and 16,388/ 14,031 = 1.168 for 2012. In terms of evaluating this ratio, the higher
the current ratio, the more capable a company is in paying off obligations. Typically, a ratio near or above
one is deemed healthy. From 2012 to 2013, there is a sizable decrease in the current ratio, specifically due
to a large drop in current assets. The reason for this decrease is attributable to Target selling the entire US
consumer credit card portfolio to TD to recognize very large gains. Essentially credit card receivables
went from 5,841 (million) to zero, which accounts for this drop in current assets. Otherwise, the items
under current assets stayed the somewhat similar from one year to the next; slight changes were seen with
cash and cash equivalents as well as inventory. The management notes mentioned nothing for these
changes. A sizable growth is seen under the Pharmacy, income tax and other receivables from 2012 to
2013, an item under Other Current Assets (Q8).
The debt to equity ratio denotes a measurement of the companys financial leverage, the amount of
debt a company uses to finance its assets. Typically, this ratio is debt divided by equity. However,
companies may classify debt differently depending on how it is interpreted. In this case, debt to equity is
measured using the ratio of total liabilities to stockholders' equity, the most common equation to use. The
debt to equity ratio is calculated as 28,322/16,231= 1.745. According to Retail Management Advisors, a
healthy ratio exceeds 1 to 1. However, most retail companies exist in a range below one. As seen in the
calculation above, the calculated ratio for Target is quite high using this equation; it could indeed be
lower depending on the classification of debt. Nonetheless, this ratio suggests that Target is very
aggressive in financing its growth with debt. Net earnings have also grown over the past several years,
excluding 2013 when a credit card breach greatly affected profits. Conclusively, Target borrows a
reasonable amount because a company achieving results as Target can handle borrowing substantial

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amounts to spur growth (Q9).

Investing in Target

After much deliberation, our group has decided that we would not invest in Target. Although Target is
a solid company and a household name in the United States, we do not believe that it presents a great
investment opportunity. First off, Target is a large corporation with seemingly limited growth
opportunities in the United States. Between Walmarts and Targets large shopping centers, the market
simply seems too saturated with large retail stores. Expanding on their competitive relationship with
Walmart, we believe Targets position exposes them to more risk revolving around the future of Internet
shopping. Walmart has dominated the market as being a value center; this is exemplified by their motto of
Always low prices, always. Target on the other hand, a similar business in terms of offerings and store
layout, differentiates them from their biggest competitor by charging higher prices and offering products
perceived as higher quality. As consumers increasingly use the Internet for shopping, Target will lose
substantially more market share to Walmart, the cost leader. Although Target operates its own website, it
simply cannot compare to Amazon and other large online retailers.

There are reservations to our negative rating. For instance, in the short term Target should receive a
major bump in revenues from the holiday season. Although most of this increase in sales is probably
already priced into the share price by the market, there is a possibility of the stock being undervalued still
due to the data breach scandal. This scandal, which caused shares to trade down considerably, could still
give investors second thoughts about paying top dollar for Target. If the company has a very strong
holiday season and beats analyst expectations, the shares could see substantial tailwind and start trading
higher temporarily. Even taking this into consideration, we do not believe the limited growth
opportunities, competing against Walmart, and the future of the online retail industry is enough to justify
investing in Targets stock (Q10).

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Works Cited

"Current Ratio Definition | Investopedia." Investopedia. N.p., n.d. Web. 03 Dec. 2014.
"Debt/Equity Ratio Definition | Investopedia." Investopedia. N.p., n.d. Web. 04 Dec. 2014.
"Target Corporate: Social Responsibility, Careers, Press, Investors." Target Corporate: Social
Responsibility, Careers, Press, Investors. N.p., n.d. Web. 06 Dec. 2014.