Target Q2 2014 Earnings Preview

Aug.19.14 | About: Target Corporation (TGT)


Target preliminary results look troubling.

Gross margins remain in doubt under the guise of strong sales events and pricing promotions.

Logistics processes are faltering at many stores.

Extended store hours may provide an opportunity to achieve new customers and late evening shopping dollars.

Target Corp. (NYSE:TGT) will be reporting its official Q2 2014 results on August 20th with a greater degree of investor anticipation than in recent quarters as many eagerly await the hear details surrounding the company's recent efforts. With the company already lowering investor expectations by issuing preliminary results and cautious statements concerning the quarter ended June 31st, the stock will likely not react to much outside of the conference call. On August 5th , the company recognized that it would incur larger expenses than originally anticipated would be associated with its massive data breach from last year's holiday shopping season. In the press release, the company lowered Q2 2014 EPS expectations to around $.78 per share from $.85-$1.00 per share. The reasons for lowering expectations were offered in the press release as follows:

  1. U.S. Segment: Essentially flat comparable sales with lower-than-expected EBITDA margin driven by promotional markdowns, as guests continue to spend cautiously and focus on value in the current environment.
  2. Canadian Segment: Somewhat softer-than-expected sales combined with the impact of continued investments to clear excess inventory.

I give the company credit for recognizing the potential dramatic disconnect from the original Q2 2014 guidance by notifying investors prior to the company's official earnings release date. Having said that, this will mark yet another earnings miss and possibly result in FY14 guidance revisions. Such action will likely continue to reflect in the share price and give investors cause for concern as it pertains to the company's visibility in projecting metrics for its business. It should not be discounted that Target has missed estimates in each of its previous 5 quarterly reports. Most recently, the company failed to achieve its stated guidance for Q1 2014.

In the 1st quarter of 2014, the company narrowly missed earnings by $.01 per share. Expectations were for $.71 per share, but the company earned only $.70 per share. Revenue, however, rose to $17.05 billion from $16.71 billion a year ago. It is important to denote the impact from the data breach that resulted in a great many sale offerings from the retail giant in attempt to regain foot traffic and conversion. Due to the additional expenses the company witnessed in Q1 2014, the underperforming gross margins from its Canadian business segment and the promotional pricing and sales campaigns in the U.S. business segment, Target's EPS during Q1 2014 fell year-over-year. In Q1 2013 the company earned $.82 a share and in Q1 2014 the company only earned $.70 a share representing a roughly 18% decline year-over-year in earnings. Ultimately, the promotional pricing aimed at bringing the shopper back to Target has resulted in a full percentage point gross margin erosion from 30.7% in Q1 2013 to 29.7% in Q1 2014. Given the lowered expectations for Q2 2014 EPS results, investors might assume similar gross margin erosion remains constant in the business presently.

There are a great many unknowns presently surrounding Target's ability to turn its business around within the current fiscal year. Having said that, it might be prudent to recognize that the question is not if the company will turn things around, but rather when will it turn things around. Investors can easily remember in the not so distant past how many were calling for the bankruptcy of J.C. Penney (NYSE:JCP). Of course those calls found themselves upon deaf ears as the company has come back to beat analysts' estimates in each of the last three quarters. J.C. Penney has even forecasted for the company to have free cash flow by year's end which is a signal of improving operational strength for the company. I only mention J.C. Penney anecdotally as I long since recognized that a bankruptcy for the beleaguered retailer was not in the cards due to a great many variables. Most retailers share the same operational variables and Target is no different in this regard. It's a simple formula of getting the consumer into the store, enticing the consumer to purchase goods and do so in a profitable, repetitive manner. J.C. Penney has rebounded from the brink of disaster by putting together sound and successful plans that could see the company turn a profit in FY15 and Target can do much the same in the future with respect to turning itself into a growth story once again.

I recently gave investors a closer look at some of the operational issues surrounding the company. We highlighted these issues that we believe are impacting both foot traffic and sales. The following illustration was offered as an example of what we saw at a vast majority of stores before the afternoon hours and while stores were open to the public.

The Target freight in the picture above is part of a truck that was unloaded in the morning by Target's Logistics Team Members. Unfortunately, what we have learned is that due to the company's need to show profit growth, there have been a great many changes that have taken place to the Logistics work center and processes. The changes that have taken place have been legislated at the executive level of Target and implemented at the store level. The most impactful aspect of the logistics process currently affecting sales for Target is that pertaining to the time for which the logistics process is taking place on the whole. Where once the logistics process was completed, for the most part, when the store opened at 8:00a.m., it is now a process that is being carried out through the morning and impacting shoppability for the consumer. The in-store logistics process is the heart of every single Target store operation. Essentially, if the logistics process is "broken", the store is "broken" and will probably underperform from a profit perspective. Having visited hundreds of Target stores during the quarter, I have concluded that at least 55% of Target stores are failing to achieve successful logistics operational status. For a greater historical perspective on defining the logistics operation at Target stores, I will follow up this quarterly preview with another article titled "Target Operations: From Green, to Yellow, To Red".

If investors put the pieces together regarding issues related to the data breach in Q4 2013, Target's logistics process issues, foot traffic and overall sales, they come to realize the chain of causation through the company's decision making post the data breach. Some 9 months beyond the data breach, Target has yet to show meaningful improvement in its much larger U.S. business segment in spite of measures taken. Comparison sales remain pressured, gross margins remain pressured and earnings continue to decline year-over-year. The data breach definitively did not cause all of Target's present problems as the company clearly was faltering with respect to FY13 guidance prior to the data breach in 2013.

Moreover, most recently Target made the decision to employ an extended hours of store operation strategy as an attempt to acquire the late evening consumer traffic dollars. Target plans to keep more than half of its U.S. stores open later starting this month, hoping to capture shoppers who put shopping off until after dark. These stores will remain open until midnight and likely operate with a very small late evening staff. According to a recent survey, only 0.3% of Americans shop after 10 p.m. on a typical night. While this might seem like an insignificant amount of American shoppers, it could provide the retailer with moderately incremental sales and greater insight into the possibility of competing with Wal-Mart (NYSE:WMT) with year-round extended hours of operation.

I am looking forward to hearing about some of the progress Target is making in spite of the issues it is currently facing. On August 20th the company will likely remedy some of the unknowns that investors are seeking for clarity. There remains a great opportunity for investors with shares of TGT as the company boasts a hefty yield and strong balance sheet to contend with weakened sales and earnings. Eventually, the Target ship will be set for the appropriate course back to growth. Time is the company's best friend as evidenced by the current turn around in the J.C. Penney business that is currently unprofitable, but on the course toward profitability. With that said, the opportunity with TGT shares is a matter of maximizing that opportunity through detailed fundamental analysis that depicts a potential time frame for such a turnaround in the business.

Disclosure: The author is long JCP. 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.