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Target (TGT) is known for selling more upscale merchandise, which generally caters to the needs of middle and upper income consumers. There was less traffic towards its stores, as consumers opted for stores that provide discounted merchandise in this weak economic scenario. This fact was evident in the company's second quarter result; where its same store sales merely grew by 1.2% . To improve sales in the upcoming quarters, Target is expected to capitalize on the holiday season in the U.S.

The holiday season starts November 28 and there are twenty-six shopping days between Thanksgiving and Christmas Day, and most retailers bet on this season for incremental revenue. This year, these 26 days are really important for retailers, as they are expected to offset decline in the previous quarter sales due to the weak economic scenario prevailing in the U.S.

How will Target capitalize on the holiday season?

Target has applied a New Price Match policy in its store. Under this policy, customers at Target stores can match the prices of its online competitors, and will select the best price to pay for that particular product. This policy will last until December 16, 2013, and is expected to attract customers to its stores during this holiday season. Target has qualified four of its competitors, which include Amazon, Wal-Mart (WMT), Best Buy (BBY) and Toysrus.com, for the price match policy. On the other hand, its competitors are also applying various strategies to attract customers during the holiday season.

Wal-Mart is providing heavy discounts on various electronics and merchandise with free shipping when purchased online. In addition to this, Wal-Mart's subsidiary Sam's Club, a membership only retail warehouse, is adding merchandise at a faster pace this year than before. In the previous year, it added 52 new merchandise options to its clubs during the holiday season, but this year it is adding 132 new merchandise options, thus enhancing the customer's shopping experience.

As far as Best Buy's strategies during the holiday season is concerned, the retailer has launched a new campaign known as " Your Ultimate Holiday Showroom," which will enhance the customer's experience when shopping its stores and online. This marketing campaign focuses on the lowest guaranteed price offered to its customers at its stores and online. This campaign will also consist of the customers' ability to order products online and pick the product up from nearest store.

On the other hand, Target also added a "Store Pickup" service similar to Best Buy, which will make it convenient for customers and save them time. We believe Target stores are expected to attract customer traffic, since customers can receive the lowest price on a product with its Price Match Strategy. Therefore, Target has a competitive edge. In addition to this, for the first time, Target is displaying the discounted prices of its merchandise in TV commercials during the holiday season. This is expected to attract customers towards its stores, and Target will be able to capitalize on the holiday season. With these strategies, management is expecting its full year 2013 comps to increase by 1% by factoring the downside risk of continuous weak U.S. spending by customers.

Balance sheet analysis

Under this, we have analyzed its free cash flows and repayment of debt obligations, which is reducing Target's interest payments, thereby improving its valuation multiples.

Cash Flow Analysis

Target generated $5.32 billion in cash from its operations in its fiscal year 2013, and after adjusting all the expense and income, the cash available for shareholders that can be paid to them through dividends and share repurchase is approximately $2 billion, up by 37% from a year ago. In the following table, we have analyzed the impact of free cash flows on its shares.

Quarter

Free Cash Flows ($)

Outstanding Shares (million)

Free cash flow per share

Fourth Quarter 2012

1.03 billion

645.29

1.6

First Quarter 2013

2.32 billion

641.25

3.63

Second Quarter 2013

-132 million

630.92

-0.2

In its recent quarter update, the company witnessed a decline in its free cash flows. The reason behind this decline was Target purchased approximately 13% more as capital expenses for its expansion plans in its second quarter than first quarter, amounting to $1.01 billion. Furthermore, the company repurchased more shares in the second quarter compared to the first quarter of 2013, negatively impacting its cash flows. However, this is a short-term decline in its free cash flows due to heavy investments and trailing high dividend yield of 2.3%. The capital expenditure of the company is expected to provide returns in the future, and this investment will not affect its cash flow generation capacity in the future. Thus, we are optimistic for its future cash flow generation capacity.

Debt repayments from strong operating cash flows

Over the past five years, Target has reduced its long-term debt obligation by 19%, bringing it to $14.49 billion as of July 2013 with its strong free cash flows. In the first half of 2013, Target repaid $3.42 billion of its long-term debt obligation. This has lead toward improvement in shareholder equity, impacting its debt to equity ratio significantly. Its debt to equity ratio has reduced to 1.07 in 2013 from 1.37 in 2009. With reducing the debt burden, its shareholders can expect a higher dividend yield, which is expected to upsurge to 2.70% going forward from its trailing dividend yield of 2.30%.

Paying interest expenses easily

Repayment of debt obligations and reducing its interest payments expenditures goes side by side. In its second quarter results update, the company posted $171 million of interest expense, which has reduced by approximately 7% year over year. This is improving its interest coverage multiple, signifying that the company can pay its interest payment on outstanding debt very easily. Reduction of 19% debt obligation in the past five years from its liabilities side has increased the interest coverage ratio from 4.96% in 2009 to 7.05% in fiscal year 2013.

Bottom Line:

Target is adopting various strategies to monetize the holiday season as discussed above. Furthermore, the company has an attractive valuation with its improved financial metric. It has a long history of distributing cash to its shareholders through dividends and share repurchase activity. Henceforth, we are optimistic on this stock for long term consideration.

Source: Target: Where From Here?