Target Corporation (NYSE:TGT) released its Q1 earnings report last week. The stock has been one of the most prominent underperformers in the last 12 months, having dropped 20% while the S&P (NYSEARCA:SPY) is up 15%. The big question is whether the prolonged decline of the stock now represents a great bargain or if investors should avoid this stock.
First of all, the adjusted earnings per share (EPS) fell 14% year on year to $0.70. That was really disappointing, as the company had previously guided for a 25% increase in its EPS of this year vs. last year. Even worse, the management lowered its projected EPS for this year by 6%, from $4.0 to $3.75. I have lost count of the number of downward revisions that the EPS of this year have incurred in the last 9 months. More specifically, in just 9 months, the outlook of this year has dropped from $5.50 to $3.75 in numerous small steps. Moreover, the recent outlook is still 15% above last year's results so I expect more downward revisions to come.
The disastrous results largely come from the great losses the company has been recording in its recent expansion in Canada. Unfortunately, the results from Canada did not show any improvement, as the losses slightly increased to $211 M in Q1. Even worse, the management did not mention any strategic steps that will improve its operations in Canada. I have watched many companies expanding abroad, some of them selling their products in more than 100 countries, but I have never witnessed such a disastrous expansion abroad.
Another disappointing factor is that total domestic sales increased only 0.2%, while the comparable domestic sales decreased 0.3%. Moreover, the EBITDA and EBIT margins fell about 100 basis points each, to 9.5% and 6.4% respectively, thus confirming the impression that the competition has lately become very intense in the retail sector. If the Canadian segment operates at a loss and the U.S. segment cannot grow, then there is nothing left to improve the results of the company. Therefore, one can reasonably wonder how long the market will continue to assign a P/E=17 to the stock.
Furthermore, the management mentioned that it cannot estimate its future expenses from the data breach incident. Even worse, the balance sheet of the company is very weak. To be sure, the current liabilities exceed the current assets by $1.2 B and the net debt stands at $27.6 B, which is about 14 times the annual earnings. That's why the interest expense reduced the net income by 20% in Q1. In addition, when the interest rates rise, the interest expense will exert even more pressure to the earnings.
Of course these weak figures do not mean that the company will face any solvency problems. However, on the other hand, they greatly restrict the company's ability to do some financial engineering to reward its suffering shareholders. Although the company has consistently repurchased its shares for years, even at much higher prices, it did not repurchase any of its shares in Q1 and will most likely continue to abstain from share repurchases for some quarters. A similar situation was observed in the case of Philip Morris (NYSE:PM); the shareholders were exceptionally rewarded until the balance sheet reached its limits but lately the distributions have normalized.
If the above factors have not formed a gloomy enough picture, the technical picture will finish the job. Since the stock reached its top ($73) about 10 months ago, there have been periods of pronounced declines, interrupted by periods of consolidation. This is exactly how a strong (downward in this case) trend looks like. There have not been any signs of bottoming yet so we should expect the downtrend to continue. The stock is likely to trade at around $50 soon, which is a reasonable valuation (P/E=15).
However, one should always remember that the downtrend of a profitable company cannot last forever and that things look worst near the bottom. As an investor, I tend to abstain from companies that face fierce competition, have little room for future growth and carry a heavy debt load. Of course, this does not mean that one can never make money from such stocks. If someone really insists on having shares of Target, I think it is reasonable to purchase shares at around $50.
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.