Taking A Closer Look At Target's Q1 2014 Results

| About: Target Corporation (TGT)


Target's Q1 Earnings drop significantly YOY.

Target's revenue and earnings issues started long before the security breach.

Target's future success relies heavily on consumer spending and household formation growth.

On May 21st Target Corporation (NYSE:TGT) reported disappointing 1st quarter earnings which resulted in further share price depreciation in the subsequent trading session. This article will help to recap the company's quarterly performance. As many Target investors are already aware, prior to the company releasing its 1st quarter results, CEO Gregg Steinhafel announced his immediate resignation from the head position at Target. Unfortunately, this action left a void at the top spot for which investors also became more keenly aware that the company did not have an appropriate succession plan in place for such a situation. John Mulligan, previously Target's CFO, has temporarily taken the "helm" at Target as the company embarks on searching for a more permanent replacement for Gregg Steinhafel. In my opinion, Mr. Steinhafel has grown Target Corp. into an iconic retail brand outlet over the last 20 years, but in doing so he has also left the company floundering amidst negative sales trends, complicated operational issues and misappropriated merchandising strategies with diminishing results as proven by the last 6 quarterly reports.

In the 1st quarter, Target achieved $.70 a share in earnings, considerably lower than the 1st quarter of 2013 which came in at $1.07 per share.

  1. U.S segment comparable sales decline of 0.3% was near the upper end of guidance and reflects improvement from trends the company was experiencing shortly after the breach last year.
  2. U.S. same store sales declined by .6 percent.
  3. First quarter comparable sales were strongest in hard lines, driven by a mid-single-digit increase in electronics, which continues to benefit from strong trends in mobile.
  4. Comparable sales in less discretionary food, health and beauty categories were slightly positive, while home and apparels saw small comp declines, with digital channels' first quarter sales were strongest in health and beauty and home.
  5. U.S. segment comparable traffic was down a little more than 2%, which was nearly offset by a healthy 2.1% increase in basket size.
  6. Digital visits were up more than 20% from a year ago, which according to comScore was the fastest growth among a group consisting of Target and seven of the firm's largest online competitors.
  7. U.S. segment first quarter gross margin rate was down more than 1 percentage point from last year.

Now let' take a closer look at the company's Canadian segment. As mentioned in Canada, Target continued to enhance operations in the first quarter and in-stocks have started to show meaningful improvement. At the same time, Target ramped up its promotional intensity to show Canadian guests the depth, breadth and pricing of assortment in frequency categories. In a recent survey of Canadian guests, Target witnessed double-digit improvements in favorable responses to questions regarding in-stocks, whether they provide a good value, everyday pricing and the quality of deals offered by Target.

  1. First quarter Canadian segment sales were slightly below plan, driven by softness in February and March and stronger performance in April.
  2. Target Canda's gross margin rate of 18.7% improved dramatically from the 4th quarter, but it remains far below where it needs to be as the company continues to clear excess inventory on long lead receipts. Since Target Canada's former president left the company recently, Mark Schindele has assumed the role of President Target Canada.

Target returned $272 million in dividends during the 1st quarter, up from $232 million last year as the $0.43 per share quarterly dividend was more than 19% higher than a year ago. The company plans to recommend that the Board authorize another similar increase this summer. Target did not repurchase any shares in the first quarter. While the company does expect to generate cash well beyond the expected uses over the next several years, current metrics are beyond typical boundaries of their middle A cart rating. As a result, the company does not expect to repurchase shares in the second quarter and may resume repurchases in the back half of the year at the earliest. To resume this activity, Target needs to see continued improvement in U.S. and Canadian operations, moving their credit metrics back to acceptable levels, relative to their single A rating. Now let's take a look at the company's guidance for the 2nd quarter and 2014 as outlined below

  1. Second quarter comparable sales should be flat to slightly positive.
  2. U.S. segment EBITDA margin rate will be below last year's 10.8% rate, but Target expects a smaller year-over-year decline than experienced in the first quarter.
  3. In Canada, Target expects sales measured in U.S. dollars to be up about 75% from last year's second quarter and about 25% higher than the first quarter.
  4. Target expects to report a single-digit decline in second quarter Canadian segment comparable sales as the company will be comparing against the very large grand opening surges experienced a year ago, combined with the impact of market densification later in 2013, which redistributed sales from initial openers.
  5. Second quarter Canadian segment EBITDA losses measured in U.S dollars are expected to be approximately flat to last year.
  6. Altogether, expectations would generate adjusted EPS reflecting results from both U.S. and Canadian operations of $0.85 to $1.
  7. For the full year, Target continues to expect U.S. comparable sales in a range of flat to up 2%.
  8. In Canada, in light of recent trends Target has taken down full-year sales expectations closer to US$2 billion and with that new view of sales, the company expects lower gross margin rate and higher expense rates than before. Specifically, now Target expects full-year Canadian segment EBITDA margin rate will be closer to minus 20% compared with prior expectations closer to minus 10%.
  9. Altogether, these updated expectations will put full-year adjusted EPS in a range of $3.60 to $3.90, $0.25 lower than the range provided a quarter ago.

Although Target is taking steps to improve its operations across a multitude of channels and consistent with industry trends, the market demographic and economic conditions in the U.S. and Canada are proving to curtail results. Lack of income growth among more moderate income families and persistent lack of household formation are hampering the pace of the company's recovery. Given Target's exposure to lower and middle income households, the environment remains challenging overall and the retailer faces the additional challenge of addressing the lingering effects of the data breach. Just like the U.S., Canada has seen economic improvement largely due to consumer spending and the housing market for the past five years and policymakers are looking to businesses, particularly exporters, to take over that role at this stage in the economic cycle.

Target's future success or failure will depend largely on the consumer and the company's ability to attract more consumers into its stores or onto its digital platforms. As noted by the interim CEO on the 1st quarter conference call, the company simply can't cut its way to growth, even though they continue to utilize cuts and reductions in labor and benefits presently and historically.

The most compelling issue regarding an investment in shares of TGT at this time is very simple; Target's problems did not begin with the data breach. In fact, the company had lowered guidance in each of the 3 prior quarters leading up to the data breach. Moreover, the company missed analysts' estimates in 4 out of its 5 previous quarterly reports leading up to the data breach in the 4th quarter of 2013. Target actually has a longer history of disappointing results than the stock price might lead one to believe as the stock climbed, along with the overall stock market, to greater than $70 a share in spite of lowering full-year guidance 3 times in 2013. If investors look even closer at YOY gross margins dating back to 2011, this metric above all others, serves to prove that the company has done very little to effectively offset weakening demands for goods sold by Target other than vast discounting. While I don't believe Target is doomed or on the verge of some collapse in long term investor sentiment, I would rather see the share price depreciate below $54 per share before initiating a long term position consistent with the thesis that Target Canada will begin to comp positively by 2015 and the economies of North America will remain on their current upward gross domestic product trajectory. For investors who are inclined to short shares of TGT, valuation suggests limited downside given low expectations for the company going forward, resumption of buy-back program possibly later this year and the current forecast for economic growth through 2014. Downside risk may be capped at 10% from the most recent closing price of $55.69 per share.

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.