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Investors in Target (NYSE:TGT) are not too pleased with a soft third quarter performance, driven by continued large losses at its expanding Canadian operations.

With the company lagging behind its long-term targets, investors are cautious on the back of slow sales growth and pressure on margins.

Third Quarter Results

Target generated third quarter revenues of $17.26 billion, up 1.9% on the year before. Revenues missed consensus estimates, which stood at $17.4 billion.

Net earnings were nearly cut in half, falling by 46.4% to $341 million. Earnings per share fell by 44.4% to $0.54 per diluted share. This missed consensus estimates by eight cents.

Looking Into The Results...

Note that sales growth of 1.9% understates the real growth at Target. Regular sales rose by 4.0%, but last year Target achieved $328 million in credit card revenues, a business it no longer owns after selling it to the TD Bank Group.

Gross margins, based on regular sales alone, fell by 60 basis points to 29.7% of total sales. Faster growth in operating expenses put further pressure on earnings as well. The lack of credit card contribution impacted margins by 60 basis points. Therefore, net earnings nearly halved to $341 million, resulting in net margins of just 2.0%.

...And The Rest Of The Year

Fourth quarter adjusted earnings are seen between $1.50 and $1.60 per share. Notably as a result of the dilution in Canada, GAAP earnings are seen around $1.26 per share. Analysts were looking for adjusted earnings of $1.56 per share for the fourth quarter.

Full year adjusted earnings are seen between $4.59 and $4.69 per share. Given the losses of the Canadian segment of $0.95-$1.05 per share, GAAP earnings are seen around $3.52 per share.


Target ended its third quarter with $706 million in cash and equivalents. Total debt stands at $14.79 billion, resulting in a steep net debt position of $14.1 billion.

Revenues for the first nine months of the year came in at $51.08 billion, up 1.0% on the year before. Net earnings fell by 28.8% to $1.45 billion, coming in at $2.26 per share.

At this pace, annual revenues are seen around $74 billion, while earnings could come in just above $2.1 billion.

Factoring in losses of 4% on Thursday, with shares trading at $64 per share, the market values Target at $40.5 billion. As such, operating assets are valued at 0.5 times annual revenues and roughly 19-20 times annual earnings.

Target currently pays a quarterly dividend of $0.43 per share, for an annual dividend yield of 2.7%.

Some Historical Perspective

Long-term holders in Target have seen mediocre returns. Over the past decade, shares have traded in a $30-$70 trading range, currently trading towards the high end of this range.

While shares have risen to peaks around $73 in July of this year, they have sold off quite a bit, trading at $64 at the moment. This means that shares are still up nearly 10% year to date.

Between 2009 and 2012, Target has increased its annual revenues by a cumulative 12% to $73.3 billion. Net earnings rose by some 20% to $3.0 billion. Earnings per share saw even more growth as the company retired roughly one in every five shares outstanding over this time period.

Investment Thesis

Target's expansion in Canada so far is not really going yet, and is the main cause behind the relative light results this quarter. Canadians are not running to their stores yet, especially not for basic items such as food and medicines, after the company started opening stores in March of this year.

For now, the company has opened 124 stores so far, hurting third quarter earnings by $0.29 per share versus expectations of $0.22 per share. This is a huge loss at $238 million before interest and taxes, especially in relation to third quarter sales of $333 million. The high losses are driven by store openings, and slashed prices to clear inventory. Gross margins were just below 15%, which are terrible margins for a retailer.

Yet the company remains upbeat, being confident with its leases and the prospects for mid-thirty percent gross margins.

While Target trades at 20 times GAAP earnings, shares trade at just 13-14 times adjusted earnings, when factoring out Canadian losses at the moment. This valuation seems fair, accompanied by fair shareholder payouts. So far this year, Target nearly repurchased $1.5 billion of its own shares, while paying out dividends of $700 million. Annualized payouts of $3 billion provide investors with a combined cash flow yield of 7-8% per annum, quite attractive in this low interest rate environment.

Back in May, I last took a look at Target's prospects. Shares sold off some 10% ever since after a weak first quarter performance resulted in a continued lower guidance for full year adjusted earnings. On top of this, losses in Canada kept increasing.

If Target fulfills its goal to achieve $100 billion in revenues for 2017, combined with earnings of $8 per share, the company is an excellent buy at the moment combined with large shareholder payouts.

The nice growth path gives investors visibility for future earnings as the 2017 goals could justify a $100 per share valuation rather easily in let's say two or three years' time. With Target lagging behind its goals a bit already, I would remain cautious. I stay on the sidelines with a long bias.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.