Target (NYSE:TGT) reports earnings next week on August 20th. With all of its recent struggles, this quarter is very important to a lot of investors - myself included as I am long TGT. I had originally bought my position in Target thinking I was buying a quality company with a strong brand that was going through a short term public relations and financial hiccup, thanks to the data breach. As a value investor, these are typically the situations I look for when choosing stocks to invest in. With the data breach identified as the catalyst for the plummeting stock price and knowing how quickly consumers tend to forget these things, I thought this would be a quick turnaround story. It was my impression that I could sit back and enjoy a dividend of nearly 4% for my efforts while watching everyone forget the data breach and Target take Canada by storm.
At this time - due in large part to that dividend - I still peg Target as a Hold. I have not sold my position, however, this earnings call may sway my opinion in one direction or another. Target recently lowered its estimates for the second quarter so we have a good idea of what to expect on earnings and I believe the upcoming disappointing quarterly results have already been priced into the stock. I am more interested to hear that management has a plan for a turnaround on the call. This article will cover the other items I want to hear about during the call to see if Target truly is a quality company in the midst of a run of bad luck or if it's really the team of lost executives bumbling their way north of the border.
The data breach was undoubtedly expensive to Target. Both in terms of finances and customer trust. However, I do not want to see that be the blame of all the problems at Target. I fear that the data breach to Target is becoming what "poor weather" is to many cyclical stocks. According to the revised guidance just released, the data breach has cost Target about $110 million after factoring in money that will be reimbursed from insurance. While this is a substantial sum of money, Target made $17 billion in revenue last quarter so it cannot bear the blame for everything wrong with Target's earnings. By Target's own admission on the first quarter conference call:
"The vast majority of our lapsed guests, those who had changed their shopping habits and not visited Target since the data breach, had come back for at least one visit by the end of the first quarter."
To further confirm this, according to this poll done by the LA Times in May, 85% of shoppers do not plan to change their spending with only 7% saying they would spend less.
Tying into the point above, considering most customers affected by the data breach have returned - I would hope to see same-store traffic in the United States remain competitive with Wal-Mart which saw a 1.1% decline. None of the major problems that Target is addressing (data breach & Canada) should be weighing heavily on same-store traffic. In this retail environment, this is actually quite a daunting task but considering the promotional pricing that Target has continued to advertise after the fallout of the data breach, I would hope to see that it is driving traffic to the store. Listening to Wal-Mart's (NYSE:WMT) earnings report, they indicated the competition as a major problem to their store traffic. I am hopeful that means that Target has taken some of that traffic from them. Strong traffic numbers would allow Target to ease away from promotions and focus on increasing its margins again.
This is probably the biggest factor for me. When Target first opened in Canada, citizens were very excited and store traffic reflected that. Target admittedly botched that first chance by moving too hastily which resulted in having poorly stocked shelves and prices that were too high - Mark Schindele was quoted as saying:
"With the benefit of hindsight, if we could do it all over again, we wouldn't have opened up that many stores, that many DCs (distribution centers), in that short a time frame. I know that much,"
With the revised guidance and updated information regarding Target, we have some additional information on this but I would like to hear more details as I need to know that the Canadian expansion is getting back on track. With the revised guidance, I know it did not in the last quarter and I'm getting concerned that it has not been figured out yet. That said - Target Canada president Mark Schindele laid out a 3 point plan for the turnaround; Fix the supply chain, competitive pricing, and merchandise selection.
The supply chain issues have been well documented and tie into the pricing problems that Target has faced in Canada. The concern I have is that on the first quarter call, this was also recognized as the problem and I question why it was not fixed already. I need to hear re-assurance that the supply chain is well on its way to being fixed. Per Mark Schindele, this fix started with all stores auditing their current supplies so that the supply chains could be reset. This has been completed earlier this month so moving forward, the guidance for Canadian store sales should not indicate that the supply chain is a problem moving forward.
The last key element to this plan was merchandise. While on initial thought, this one sounded the least important to me, the more research I do on Canadian shoppers - the more it sounds like this will be the key to success in Canada. With Canadians being able to so easily cross the border for American products - it makes sense that Target Canada would need to sell exclusive products for Canadians. Target announced they would be rolling out 30,000 new products in Canada and reached a partnership with celebrity interior designer Sarah Richardson. According to Amazon - pre orders for Sarah's book, Sarah Style, which is to be released in November is already the #1 best seller in Interior Decorating and #5 overall in Home Improvement & Design and she was named as one of Canada's foremost "style-makers" by Canadian House & Home magazine. Sarah appears to be the type of Canadian influence that could make Target a Canadian home goods brand as opposed to an American brand in Canada. I don't think we'll hear too much about this on the earnings call but I would like to hear that Target is working on similar partnerships & product lines.
This one seems to be overshadowed a bit as it's still only a small driver of revenue for Target but online sales were seeing some great growth for Target last quarter. After the first quarter, digital visits were up 20% and conversion rates - both online and on mobile - were increasing. Both of these factors led digital channel sales to be up more than 30% from the previous year. This growth needs to continue for Target to ever reach its goal as the omni-channel retailer that it wants to be. This growth was after the data breach so I would expect Target to be able to continue this growth without blaming the data breach for any retractions in this segment.
This is another big factor - I need to know that the dividend is safe. The current payout ratio sits at a dangerously high 56%. By comparison, two of Target's closest competitors - Wal-Mart & Costco (NASDAQ:COST) are at 39 and 29%, respectively. I need to hear from management that they can complete this turnaround and that my dividend is safe while they do it.
The other part of this is share buybacks. At this time, Target is not a big proponent of share buybacks; however, seeing the company begin to invest in itself during this time would give me confidence that management is enthusiastic about its chances at a turnaround. With a new CEO on board, this may be an ideal time for Target to implement this practice.
Factoring in what we already know from the revised guidance - for me to remain a Target shareholder, I need to see that Target's management has a firm grasp on a Canadian turnaround, that Target's traffic is in line with competitors, the dividend is safe, and that management is taking accountability for further mistakes and not using the data breach as a scapegoat. If these items are in-line and I can get back on board with the Canadian expansion - although at much more modest growth rates - then Target would still represent a decent margin of safety and be worth holding onto. Using the Benjamin Graham formula, Target would represent about a 24% margin of safety to go along with a 3.6% dividend.
Disclosure: The author is long TGT. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.