Coming to Canada is turning out to be more expensive for Target Corp. than it had originally counted on.
The U.S. discount retailer is locked in complex negotiations with an array of landlords as it picks up as many as 220 existing Zellers stores and converts them to the Target banner by 2013. It's all part of the chain's $1.8-billion deal with Hudson's Bay Co. for rights to the Zellers leases, the first half of which is to be paid at the end of next week, when Target is expected to unveil its first batch of locations in Canada.
Target is driving a hard bargain with landlords to get concessions, including long-term leases, money for renovations and plenty of parking spaces. But the retailer is also finding that it needs to spend more money than it had planned for the Canadian launch - enough to drag down its estimated profit per share by 16 to 20 cents (U.S.) this year, far higher than its previous estimated cost of 10 cents a share. That implies its Canadian expansion will cost up to $139-million this year.
Target has been spending heavily on its Canadian preparations, shelling out $11-million in its most recent quarter. It's putting together an executive team for its division here, which "is deeply engaged in studying Canada broadly, along with each of the separate markets throughout the country," said Gregg Steinhafel, chief executive officer of Target.
"We're still in the process of evaluating sites, working with landlords for the current Zellers stores to determine which sites we will begin to release and, subsequently, how many of those sites will become Canadian Target stores."
The stakes are high, not just for Target but also for landlords and other retailers that are anxiously waiting in the wings to snap up leases that Target rejects, amid a dearth of attractive store locations in Canada. The jostling comes as a growing number of foreign retailers are looking to expand in Canada, putting pressure on incumbents, including Canadian Tire Corp. and Wal-Mart Canada Corp., to strengthen their business before competition gets more intense.
"It's a chess game and negotiations will go down to the wire," said Alex Arifuzzaman, partner at retail specialist Interstratics Consultants. "The biggest concessions will come from properties which have the most to gain by getting a Target and these will typically be the mid-tier ones with high vacancy and low rent."
Industry sources suggested that Target is close to signing lease deals with such major landlords as RioCan Real Estate Investment Trust and Cadillac Fairview. Executives of the shopping centre operators did not return calls. Other mall owners involved in the talks include Ivanhoe Cambridge, First Capital Realty Inc., Primaris Retail REIT, Oxford Properties Group and Calloway REIT.
The costs are higher than expected because Target is closing deals faster than anticipated, which means it will be sitting with stores that aren't yielding revenue for a longer period, said Wayne Hood, retail analyst at BMO Nesbitt Burns. "If you take a lease earlier, you're going to have more upfront costs."
But Target also said it is boosting its own internal projections of how much money it can earn in Canada. "Both the expected profits once we open in Canada and the expected burdens prior to opening are larger than we thought was likely 90 days ago," Douglas Scovanner, executive vice-president and chief financial officer at Target, said on Wednesday.
Target is pushing for flat-rate leases that could extend for up to 60 years, while landlords typically opt for 20-year deals with eight five-year extension options, industry sources said. The U.S. retailer also wants its stores shut down for six months while renovations are done, while developers worry that closed anchor stores tarnish the image of an entire mall.
And Target is looking for big reinvestments from the landlords, ranging from fixing roofs to repaving parking lots, sources said. It wants landlords to wipe out a provision in Zellers leases under which they collect a percentage of sales.
Target is expected to generate roughly $300 of sales per square foot within a few years of operating here, at least 50 per cent more than those at Zellers currently, according to estimates in a National Bank Financial report earlier this year.
Jeff Doucette, a principal in Calgary-based consultancy Sales Is Not Simple, has compiled a list of 193 of Zellers' total 273 stores that he thinks are most likely to be picked by Target. He based his predictions on his familiarity with Zellers stores - he used to work for suppliers of the retailer - and on Target's operations in three border states - Maine, North Dakota and Montana - which are sparsely populated and have one Target store for every 187,000 inhabitants.
He also put together a list of the 20 busiest Zellers, where Target could make a big splash in its launch. They range from Vancouver's Oakridge Centre to Calgary's Chinook Centre, Square One in Mississauga, and Shoppers World in Toronto.
Landlords that currently house a Zellers can gain considerably if Target moves into their buildings. The retailer is expected to act as a magnet, drawing shoppers to smaller malls they previously avoided.
"Replacing Zellers with Target is almost like going from worst to first in terms of an anchor," said Michael Smith, an analyst at Macquarie Securities. "For most landlords, there will be a significant amount of higher rental rates from adjacent tenants. It will also be a lot easier to get a loan on a property anchored by a Target compared to a Zellers."
Smaller landlords have the most to gain, and may have to give in to more of the retailer's demands to secure a deal, said RBC Dominion Securities analyst Neil Downey. "The strongest landlords and those with premier assets will have the upper hand, even when bargaining with Target," he wrote in a report.
Smaller landlords may be in a position of less influence, he said, and may be "required to contribute capital to the redevelopment, expansion, and conversion from the Zellers format."
Target has forecast that it will roll out between 100 and 150 stores in Canada, and eventually more than 200. It expects them to ring up $6-billion-plus of annual sales and EBITDA (earnings before interest, taxes, depreciation and amortization) of at least 10 per cent within six or seven years, Mr. Scovanner said last month.