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NEW YORK — Target Corp. might have found its sweet spot: the mall.

As Federated Department Stores Inc. looks to shed 75 overlapping stores following its acquisition of May Department Stores Co., which closed Tuesday, mall owners could turn to Target to fill those vacant spaces.

Although Target has been in malls since the Seventies, the timing is right for such a move. The retailer has shed Mervyn’s and Marshall Field’s and is outperforming the competition in terms of hipness and marketing prowess. And thanks to hefty, annual redevelopment spending, stores have caught up with savvy marketing techniques. The retailer is also delivering robust profit growth.

The $47 billion mass merchant is uniquely placed between the $285 billion Wal-Mart Stores Inc. and the $30 billion Federated in terms of revenues, but also market share and target demographics. In sales terms, Target’s closest rival is Sears Holdings Corp. with $55 billion in revenue, but analysts don’t consider Sears Holdings a strong, direct competitor to Target because its sales are divided between Sears and Kmart nameplates.

Target already bears the marks of success — it has roughly doubled its pretax earnings, diluted earnings per share and revenues over the past six years. Today it will announce same-store sales for August. Comps in its discount stores are expected — for the 19th consecutive month — to outpace those of its biggest competitor, the goliath from Arkansas. Target and Wal-Mart did not return calls seeking comment.

But even though it has the funds for a fast expansion play (as of July 30, Target had $696 million in cash and cash equivalents on its balance sheet, while cash flows totaled $1.6 billion), it is not aggressively adding stores or going global with its retail platform. In fact, the sprawling retail stores of Target might soon be relics. Although the majority of its stores are still stand-alone, much of the future growth potential will be in unlikely real estate: enclosed malls.

“The same people that shop at Neiman Marcus shop at Target,” explained Peter Lowy, managing director of Westfield Group, which has seven Targets in its U.S. portfolio and is building two more. “There’s no reason why they shouldn’t be in malls.”

This story first appeared in the September 1, 2005 issue of WWD.  Subscribe Today.

The company has had a presence in malls throughout its history, but has been pushing more aggressively into the mall arena. General Growth Properties, for example, added Target to a regional enclosed mall in the late Seventies, and for the next 15 years, “in almost every instance that we were building malls from the ground up, we put Target in as an anchor,” said John Bucksbaum, chief executive officer of the real estate investment trust.

“We’ve always felt that they were a wonderful addition and attraction to a retail project,” he said. “In many traffic studies, we found the entrance from Target stores in the mall would be the strongest entrance through a department store.”

The affection seems mutual. In 2004, for the first time, Target earned a spot on Simon Property Group’s list of top 10 anchors in its regional mall portfolio. Other anchors include Sears, Federated and J.C. Penney. Its 12 stores in Simon malls, a total of 1.5 million square feet, placed the retailer ninth on the list for the country’s largest retail developer.

Just this year, Target has opened at Simon’s Wolf Ranch project in Georgetown, Tex.; is expected to open in two more Simon retail projects in the fourth quarter, and is planning a July 2006 opening at Simon’s Crossroads project in Omaha.

In the REIT’s community and lifestyle portfolio, which includes all open-air centers, Target is its largest retailer, with 1.3 million square feet in 10 stores. Wal-Mart, which does not have any significant presence in the company’s mall portfolio, is the second largest retailer in this segment, with 1.1 million square feet in 10 stores, mainly in open air centers. Wal-Mart opened its first multilevel store designed for a mall in late 2004 in San Diego, and only has a handful of other mall locations, where it took over vacant department stores.

“From a demographic perspective, it is easier to incorporate Target into a mall than it would be to do with Wal-Mart,” said Bucksbaum. “The typical Target customer is going to fit almost any mall demographic.”

Stephen Lebovitz, president of CBL & Associates Properties Inc., a major mall owner in the Southeast, agreed. “They bring in a very attractive customer that is comparable to the department stores and some of the successful specialty stores,” he said. “We don’t feel like it’s trading down at all.”

Wal-Mart, on the other hand, generates boatloads of traffic, but is not necessarily helpful to a mall because its customers tend to do all of their shopping at Wal-Mart and then leave the property, Lebovitz said. CBL already has three Target stores in its mall portfolio, and has plans to open a new store in Florida this fall. It expects to break ground on a store in Pennsylvania soon. J.C. Penney is said to be another anchor.

According to Ian Gordon of Sanford Bernstein & Co. LLC, Target has roughly 100 stores, or approximately 10 percent of its real estate, in traditional malls.

Meanwhile, in the past five years, Target has grown its total portfolio conservatively in comparison to Wal-Mart, adding only 331 stores from yearend 2000 to yearend 2004. At the same time, it is spending an average of $400 million to $500 million annually to redevelop existing stores, a critical move in strengthening the brand.

“The Target experience is not just in its store, it starts in the parking lot,” said Andrew McQuilkin, vice president at FRCH Design Worldwide, which has worked with Target on designing stores. “They are continuing to evolve the way they treat their whole space, even with their lighting and sidewalks. There’s a brand point of view on everything.”

Target said in its 2004 annual report that it expects to increase its square footage by roughly 8 percent in 2005, in line with its growth last year of 65 new stores and 18 new Super Target stores. It expects to operate 2,000 stores by 2010, an increase in store count by roughly 50 percent. The expansion will be all domestic. Target does not have stores overseas.

The story of Target and its future can’t be told without mentioning its number-one competitor: Wal-Mart, whose future isn’t as wide open as Target’s, at least domestically. While Wal-Mart has growth opportunities in the grocery business, according to analyst Emme Kozloff, also of Sanford Bernstein & Co. LLC, “the question for them is really how much does it cost to operate their stores. And right now it’s been very difficult for them to offset some of the cost pressures. They can still expand and the issue is how profitable is the business versus years ago.”

Wal-Mart said in its latest annual report that it plans to add 250 supercenters and 45 discount stores in fiscal 2006.

Keeping up with Wal-Mart’s store growth doesn’t exactly seem to be in Target’s plans anyway. Kozloff, for one, said Target has another five years of healthy growth before the store base becomes saturated.

In terms of revenue, Wal-Mart is six times larger than Target. But in terms of earnings growth, Target clearly outpaces the behemoth. Target’s average earnings growth rate over the past five years is 26 percent, which is nearly double Wal-Mart’s 14 percent.

Target may be surpassing Wal-Mart on a store-to-sales basis, too. In 1993, for example, Wal-Mart had total revenues of $55.5 billion, $43.1 billion of which were from Wal-Mart’s 1,880 discount stores and supercenters. Comparatively, at now more than 1,350 discount stores, including 141 Super Targets, Target operates roughly 300 fewer stores than Wal-Mart did in 1993. But with total revenues at $46.8 billion, Target easily surpasses Wal-Mart’s 1993 total sales per square foot.

Target is more healthy than Wal-Mart from a stock market perspective as well. Trading at around $54, Target’s stock has risen about 21 percent in the last 52 weeks, though the shares are about $6 off a 52-week high. More impressively, in the last five years, Target’s stock price has more than doubled.

Wal-Mart, meanwhile, has had a relatively flat stock price over the past five years. At about $45, the company’s shares recently dipped to a 52-week low, and the shares are down about 14 percent year-over-year.

Meanwhile, Target is expecting its same-store sales for August to be at the high end of its 4 to 6 percent guidance; the results will likely come in ahead of Wal-Mart’s consolidated 3.3 percent rise, which it announced on Saturday, and could be revised today.

One reason Target is ahead of Wal-Mart from a comp-store sales basis is because its merchandise assortment of well-marketed apparel consistently draws customers, while Wal-Mart customers tend to shop for household supplies and groceries. Food, for example, is a low-margin product, compared with apparel. And Wal-Mart’s core customer, of whom the company has said roughly 20 percent do not have checking accounts, is more affected by soaring gas prices than Target shoppers, who have higher incomes.

While Wal-Mart has several opportunities to beef up comps, apparel is one the most talked about areas. Moody’s Investor Service has estimated that Wal-Mart’s apparel division brought in $33 billion in sales in 2004.

So where can Wal-Mart get inspiration to improve its apparel assortment? Chief rival Target, of course.

“The biggest challenge is striking the balance between sticking with their core customer and moving up the [demographic] chain a little bit. I think that Target does that well and I think [Wal-Mart is] not too proud to take a play out of Target’s playbook,” said Joseph Beaulieu, equity analyst at Morningstar.

Wal-Mart has had a “very, very poor fashion positioning and that void was filled to a great degree by Target, who brought in Isaac Mizrahi and Mossimo and any number of brands,” said Martin Brill, president and ceo of retail consultancy Sweetwater Consulting Inc. “When you go into Wal-Mart, at this point, it’s just a lot of items that really don’t come together as a statement.”

Even though Wal-Mart might be looking to Target for inspiration, it doesn’t mean Target is in the clear in terms of improving its own apparel category. “One of the things I think Target needs to work on more is giving people a better sense of head-to-toe dressing, coordinates. They’re moving in that direction,” said Brill.

Wal-Mart, on the other hand, is “coming from way behind,” said Kozloff. “They don’t have a brand image that lends itself to fashion. The consumer taste level has been rising the last four years and Target is well-positioned to capture that and take advantage of that and to grow with it.”

Indeed, with Target’s mall strategy in place, healthy financials and focus on fashion for the masses, “There’s a much greater upside right now for Target than for Wal-Mart,” Brill concluded. “If there’s such a thing as capturing a niche within the mass market or the discount business, they have done it.”

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