Excerpted from Market Derived Signal: Wider CDS Spreads May Indicate That Target Corp. Is Off The Mark
A recent widening of the spread on Target’s (NYSE: TGT) credit default swaps is raising concern as the spread is moving closer to a “BBB” rating level than the “A+” Standard & Poor’s corporate credit rating it has held for the past three years.
Target’s CDS was similar to other CDS spreads in the market during the past year. Spreads widened in fall 2008 and have generally tightened since then. Last summer, Target’s CDS spreads were close to the ‘A’ consumer discretionary benchmark but widened toward the ‘BBB’ consumer discretionary benchmark in November 2008 as the market became uneasy. With the tightening since then, Target’s CDS spreads have slowly crept closer to its ‘A+’ consumer discretionary benchmark. However, since mid-July, Target’s CDS spread began to widen again, possibly signaling concerns about consumer spending and the upcoming back-to-school season.
With the widening move, the spread crossed over the ‘A-’ consumer discretionary benchmark and is once again moving toward the ‘BBB’ consumer discretionary benchmark.
S&P highlights several factors of concern with Target:
- Target has relatively high leverage (3.1x debt to EBITDA and 57% debt to capital) compared with other retailers. Target also has lower margins (EBITDA margin of 9.4%), compared with Kohl’s (12.6%) and Nordstrom (11.9%), likely because the company is a discount retailer. Additionally, its three-year EBITDA growth is lower than that of Kohl’s and Nordstrom’s, which potentially reflects Target’s more mature status.
- In just over two years, Target’s margins have materially declined. Gross margins dropped 150 bps to 28.4%, and EBITDA margins are down 160 bps to 9.2% since year-end 2007. The margins decline was possibly owes to an adverse change in its sales mix.
- Target’s debt increased since fiscal 2007 as the company likely used proceeds to develop its credit business. During that time debt to capital increased to 57% from 39%, and total debt to EBITDA grew to 3.1x from 1.5x.
[ Target Tuesday reported better-than-expected earnings for the second quarter, though same-store sales fell 6.2 percent from a year earlier and credit card profits fell 15%.]
