The Paradox Of Target's Recent Share Price Gain

Mar.11.14 | About: Target Corporation (TGT)

Summary

Target was trading quite low before its recent earnings call, for various reasons. The day after the earnings call, the stock price went up 8%.

That rise was incongruent with the results announced. The company announced two different EPS figures, one that took into account the Canada/security breach losses (GAAP-EPS), and another that didn't (adjusted-EPS).

The greatly inflated Adjusted-EPS figure was the one that has been used as a comparison to the analyst estimates, which seem to have used actual EPS.

This resulted in what seemed to investors to be a 60% increase of estimated/reported EPS, which misdirected the public into thinking that Target did much better than it was estimated.

This confusion was partly the media's fault for misreporting. However, Target had a big role to play in the situation by putting the adjusted-EPS figure in the spotlight.

On February 26, Target (NYSE:TGT) released the financial results for Q4 2013, a period that included November, December 2013, and January 2014. The key features to note from these results, compared to the exact same period last year, is a decrease of 3.8% in sales and a 46% decrease in net profits.

Those bad results are attributed to various reasons, which include the poor sales performance of the company in its recent expansion in Canada and the winter storms which resulted in reduced shopper traffic during December, as well as store closures. Some even attribute a large portion of the bad results to the rise of online retailers. The one that gets the most credit in the case of Target, however, is the infamous security/data breach that plagued the company in December.

Those topics can be a subject of rigorous analysis and discussion (with plenty of disagreements on what influenced sales and to what degree). That is not the theme of this article however. What I want to emphasize is that, no matter the reason, there has been a general agreement amongst investors that Target's performance for the previous quarter would take a hit. They had been expecting it. That was reflected on the stock's price, prior to the earnings-call, as well as the analyst estimates.

This brings up the question: Why did people buy Target and hike its price to over $62 right after the financial results? The results announced weren't actually any better than estimates. Wall street consensus for earnings per share was 0.80 and the actual (GAAP) EPS for Target had been 0.81. Did that extra cent per share warrant a nearly 8% rise in Target's stock price the day after the results came out? I don't think so. Logic says that Target should have stayed in the price range it was trading at.

I have attempted to interpret the paradoxical optimism after the announcement. Here are my insights:

The company misdirected traders using Adjusted-EPS.

The analysts' prediction of the actual earnings per share had been (nearly) spot on. However, the company emphasized the Adjusted earnings per share, which ignore Canada results and the data breach costs. Apparently that modification can be done to "non-recurring" expenses. They have assumed that bad Canada sales, since it was the first year of opening, and the data breach will not recur. Fair enough.

As you can see from the link of Target's report, they show the adjusted EPS on the very first line at $1.30. They don't mention anything about Canada or the breach; you have to scroll way down to find the actual adjustments. Some people might have been confused. Since estimates were at the range of 0.80, people who might not have know any better might have been influenced and assumed that the actual EPS has increased by that much. An initial bullish reaction might have caused a domino effect in Wall Street and hiked the price up 8%. This surgical operation on EPS by Target has even tricked the official NASDAQ website and this particular news report on SeekingAlpha. I can only wonder what other sources had reported distorted results because of the emphasis of Target's doctored EPS.

By the way, the same period last year (3 months ending February 2013), the actual earnings per share, as instructed by the generally accepted accounting principles (GAAP), were $1.47. I hope you see what I am seeing. That Target created the Adjusted EPS figure of $1.30, put it on the spotlight and made much of the public believe that the EPS has "only dropped 17 cents". In reality it has dropped 66 cents, a 44.5% drop.

I like to believe that people are usually more thorough in their investing decisions. That's probably not the case in reality, though. I am sure that in the heat of the moment, people get carried away. Not everyone will bother checking whether on an earnings reporting day there has been two different EPS figures reported, with a vast gap between them - especially the adrenaline junkies. You know the ones I am talking about.

There has been additional manipulation of the actual EPS.

Target's (average) shares outstanding have fell 3.3% for the trending year. I cannot think of another reason why, other than the one that Target has bought back shares and vanished them from circulation. Less outstanding shares means that each share gets a larger piece of the profits, hence the EPS figure jacks up.

People might have realized that the breach will not matter in the long run.

It is true, actually. Companies such as The TJX Companies (NYSE:TJX) who had been a victim of a large security breach (in similar proportion with Target's) have recovered. It might have affected sales temporarily - shoppers lose heart in shopping at a place where their data had been compromised. However, they forget about it after some time, as the TJX case has shown. Plus, the costs for Target are not that much (just $17 million at the moment, although that will increase with the expected lawsuits and other costs). And those costs are indeed non-recurring. Unless they get hacked again!

Perhaps people saw the $17 million net loss number related to the breach (expenses for the breach were more actually, but the company received some insurance compensation) and thought, "it's OK, Target will be fine. Let's buy it back".

So, what was the reason for the price hike?

I don't think that people suddenly realized that Target is undervalued and bought it, right after the financial results. I am talking about a situation in which during a period of 2 months, a stock took a plunge of 8% and then suddenly rose back again. And this rise happened right after the earnings call. Which wasn't favorable.

This situation is definitely paradoxical. I believe that psychology plays a big part in the crazy unpredictability of Wall Street. Learning about what makes people tick, how they respond to the information that is presented to them, and how exactly that information is presented to them is important to the general understanding of things.

In the end, I think it was a matter of misdirection and confusion. If the analysts have included the adjusted-EPS figures (Canada/breach) in their estimates, then they wouldn't have been that much off. There is a large gap between 0.80 cents and 1.30 cents.

Think of it this way: If the analysts did indeed include the adjusted-EPS figures in their estimates, then what would their estimates be for the GAAP EPS? Wouldn't that fall as low as 40 and 50 cents per share? Sounds implausible to me.

Then, there's the moral issue...

It wasn't illegal what Target has done. They are allowed to use Adjusted-EPS, as long as they report the actual EPS (which they did). And they are allowed to buyback shares to change the EPS number, amongst other reasons. The point is that the company has put additional emphasis on Adjusted-EPS, and it seems that Wall Street used that number to compare it with the current 0.80 consensus and make it seem like a great improvement. Given the scope of Canada's losses (combined with the smaller security breach losses), that great improvement, at least for this year, shouldn't exist.

I gave it a stab. I am curious as to what you think about my analysis. Did you find it likely that the analyst estimates of around 0.80 EPS included the dismissal of the Canada/breach losses? If yes, then how come they have mis-estimated the EPS by so much?

Do you believe that adjusting EPS by that much, and putting it in the spotlight, is ethical?

Are the Canada losses, which added 40 cents to the Adjusted-EPS figure, really only a "one-time" loss?

My investment thesis on Target

I know this might be a bit in contrast to the general point of the article, but I really do believe that Target should be priced more anyway, despite the current misfortunes that the company is facing, and the misdirection that occurred due to the latest earnings engineering.

There are quite a few authors here on SeekingAlpha that believe that Target is undervalued, and I am one of them. I believe that it still is undervalued and that it was already undervalued before the data breach issue. For it's earnings and size, its market capitalization value is too low. I make a more detailed case about it here.

In short, Target has a low price to book ratio, and high net profit margins. The company has consistent earnings, and if the Canada situation is indeed redeemed, then I see the company's stock rising even further.

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.