Target - Situation Is Stable As Challenges Remain For The Turnaround Story

May.21.14 | About: Target Corporation (TGT)

Summary

Target is plagued by structurally slow comparable sales, the data breach and the awful Canadian expansion.

The company is making progress on these issues.

Yet more effort and time is needed before things will improve.

Investors in Target (NYSE:TGT) hardly reacted to the first-quarter results for which consensus estimates have already been lowered following the harsh weather and the consequences from the data breach.

Results could be worse as Target is making the right moves in addressing its issues. It will take time before a meaningful improvement in the situation can be realized.

First Quarter Highlights

Target reported first-quarter revenues of $17.05 billion, which was up by 2.1% compared to last year. Despite the modest increase in reported sales, net earnings fell by some 16% to $418 million.

Thanks to modest share repurchases, the fall in earnings per share was limited to 15%, with earnings falling by eleven cents to $0.66 per share.

Reported earnings of $0.66 per share came in four cents lower than adjusted earnings, which the company foresaw between $0.60 and $0.75 per share. The difference between both earnings metrics is largely the result of costs related to the data breach.

Looking At The Segments

U.S. sales inched up by 0.2% to $16.66 billion, as comparable sales fell by 0.3% which was better than consensus estimates which were looking for a fall of 1.1%. Poor traffic as a result of harsh weather resulted in a 2.3% decline in the number of transactions offset by a 1.8% increase in pricing and a 0.3% increase in the quantity per transaction.

Margins were under severe pressure, falling by 120 basis points to 29.5% of sales. The company managed to offset some of this pain by reducing selling, general and administrative expenses by 30 basis points to 20.0% of sales.

The troubled Canadian operations reported revenues of $393 million versus revenues of just $86 million last year. Gross margins fell by nearly 20 percentage points to 18.7% of sales as EBIT margins came in at -53.7%. Reported EBIT losses were $211 million, virtually unchanged from a $205 million loss reported last year.

Second Quarter Guidance

For the current second quarter, Target foresees adjusted earnings of $0.85 to $1.00 per share.

As a result of the soft quarter, Target now foresees full-year adjusted earnings of $3.60 to $3.90 per share, down twenty-five cents from its previous guidance. It has identified costs totaling at least seven cents per share related to the data breach which will impact GAAP earnings, yet Target acknowledges that these costs could increase.

The lower guidance is largely based on an expected increase in costs, not disappointing sales. Higher discounting and higher e-commerce investments are expected to impact profitability.

Valuation Of The Business

Target ended the quarter with $715 million in cash and equivalents. Total debt stands at $14.1 billion, resulting in a net debt position of around $13.4 billion.

To preserve its credit rating, and to avoid a build-up in debt in these uncertain times, Target has not repurchased any shares during the quarter.

At around $57 per share, Target's equity is valued at $36 billion. As sales should be able to come in around $75 billion, equity is valued at roughly 0.5 times sales. Shares currently trade at 15-16 times the guided adjusted earnings for the coming year.

The company's current quarterly dividend of $0.43 per share provides investors with a decent dividend yield of 3.0%.

Update On The Data Breach

The company acknowledged that traffic was "dramatically" better in the first quarter compared to the ending of the fourth quarter. Traffic improved throughout the quarter, as the weather and consumer awareness of the data breach faded.

During the shopping season, some 40 million payment card numbers were stolen after the company ignored early warnings about a security breach. This resulted in former CEO Gregg Steinhafel losing his job, he was replaced by CFO John Mulligan.

Target incurred $18 million in net expenses related to the data breach. At the start of 2015, the entire REDcard portfolio should be replaced with a MasterCard (NYSE:MA) chip and pin-cards. This conversion of cards already cost the company $13 million during the quarter.

Implications For Investors

The data breach is just a portion of Target's problems. Other issues include chronically low comparable store sales growth and the huge disappointment from the Canadian expansion. Target recently ousted Tony Fisher who headed the Canadian operations as the company hopes to move "quickly" to improve results.

Interim CEO John Mulligan is happy with the signs of the improvement of the Canadian operations and the stabilized situation regarding the data breach. Yet Mulligan acknowledges that the company has to move quickly. Key staff members have been replaced while the company focuses on driving U.S. traffic and focusing on its omni-channel operations.

I largely agree with his observations. While the company has issues, shares trade at 15 times adjusted earnings. A re-acceleration of U.S. growth and vast improvements in Canada could be huge drivers for next year's earnings, and improve the growth prospects of the firm. This could make the firm an interesting investment opportunity for the long-term.

For now, don't expect spectacular things in the short-term, but long-term investors with confidence in the turnaround could buy on dips.

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.