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Research analyst, valuentum
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US retail powerhouse Target (TGT) reported a mixed bag for its first quarter last Wednesday morning, highlighting what seemed to be a difficult start to the calendar year for several retailers. Sales fell short of consensus estimates, growing just 1% year-over-year to $16.7 billion. Earnings per share, adjusted for several charges, were 5% lower than a year ago at $1.05, which was still slightly better than consensus expectations. Thanks to the sale of receivables, free cash flow totaled $2.3 billion.

Consistent with what we saw from competitor Wal-Mart's (WMT) results, the core business in the US was relatively soft, with same-store sales falling 0.6% during the period. Overall sales were still 0.5% higher at $16.6 billion. Regardless, the company cited difficult weather comparisons that weighed on apparel and other seasonal items as the drivers of weakness. While we've yet to hear from Costco (COST), we do know the firm's comps were "soft" (for Costco) in March and April, with same-store sales up 4% each month. Costco's results, coupled with what we've heard from Wal-Mart, leads us to believe that--more than anything--the first quarter was an industry issue rather than a specific problem at Target. Let's not forget that high-priced electronics have been weak at all brick-and-mortar shops, so this likely negatively impacted results. Target, like Wal-Mart, indicated that consumer staples were relatively strong during the first quarter, and we think the firm is taking grocery category share from traditional grocery stores.

Going forward in the US, we like the reduced risk profile associated with selling credit card receivables, and we like that the company was able to use these funds to reduce debt levels. We're big fans of the City Target concept since the firm has been able to avoid the same stigma that Wal-Mart has developed with some shoppers in urban markets. If trends towards re-urbanization in the US remain intact, we think City Targets could take off, particularly since the brand is so familiar (and liked) by current middle-upper income suburban dwellers. Some of the City Targets we've seen simply interact with the urban consumer that drives less and may make more frequent trips than the megastores in the suburbs. We also like the direction Target's online business is heading. First-quarter digital sales increased in the high teens, and the company seems inclined to experiment with policies like same-day shipping and to invest heavily in mobile apps. Target's long-term same-store sales growth rate of 3% looks fairly reasonable.

Canada remains a huge growth possibility for the company, and the first quarter was off to a decent start, as the firm produced $86 million in sales. Management indicated that the rush of traffic and initial 38% gross margin (versus 30.5% in the US) exceeded internal expectations, and it appears as if it could become a real sales driver going forward. Of course, initial investments drove a loss in the segment and will continue to do so for the year. Still, we think the investment will be accretive to shareholders in the next several years.

With a slow start to the year, Target lowered its full-year earnings forecast to $4.70-$4.90 per share from $4.85-$5.10 per share. Though we're disappointed to see the earnings outlook reduced, we're confident that the firm's business model looks attractive over the long run, so we do not anticipate a change in our valuation.

The company does a fantastic job of returning excess cash to shareholders via share repurchases and dividends-though we don't regard repurchases as the best use of capital at this time. Target's dividend is likely to increase over the coming the years. Nevertheless, we think shares are fairly valued, so we do not have interest in adding them to our portfolio at this time.

Source: More Retail Weakness: This Time It's Target