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Summary

  • In today's earnings report, the management of Target continued its string of lowering its guidance for this year’s earnings. From the initial EPS $5.50 a year ago to $3.20 now.
  • Despite the lower guidance, the company has to improve its performance by 70% in the second half of the year in order to meet the guidance of its management.
  • Given the performance and the debt figures I analyze, I expect the management to lower again its projected earnings in the next few weeks.

Target Corporation (NYSE:TGT) has been a prominent underperformer in the last 12 months. To be sure, its stock has declined 13% while the S&P (NYSEARCA:SPY) has advanced 20%. Therefore, its shareholders have been looking forward to the Q2 earnings report that was released today, looking for a turnaround in the disastrous Canadian operations or any positive surprise. Unfortunately, the report had nothing new compared to all the earnings reports of the last 12 months.

First of all, the company continued its record string of lowering its guidance for this year's earnings. I was confident that the company would significantly lower its guidance again, as I detailed in my previous article. In fact, the management has lowered its guidance for this year's adjusted earnings per share [EPS] several times so far, for a total downgrade of about 40%, from $5.50 to $3.20. As the pattern has been obvious, it would have been more honest to provide a reasonable estimate from the beginning, but the management prefers to adjust its estimates in many steps to help its shareholders digest them more readily.

Even worse, the company still expects to earn GAAP EPS of about $2.72 ($3.20 minus $0.48 special charge) this year, which means that its performance in the second half of the year should improve by 70% compared to the first half. Although the Christmas effect will somewhat boost the earnings, I believe that the 70% improvement is unattainable under the current circumstances, and hence I expect the management to lower its EPS guidance again in the next few weeks.

The performance in the U.S. segment, which accounts for 97% of the sales, was disappointing. Despite the great effort of the company to boost its sales via promotions, the comparable sales remained flat compared to last year. The promotions resulted in depressed gross and EBITDA margins, from 31.4% to 30.4% and from 10.8% to 10.0%, respectively. These figures confirm the widely held notion that the company struggles to maintain its sales in a hugely competitive environment.

The Canadian segment was much more disappointing, as it experienced a 11.4% decline in comparable sales, with a collapse in its gross margin from 31.6% to 18.4%. The losses of the Canadian segment aggravated from $169M to $204M, with no positive signs on the horizon.

Another negative parameter is the leveraged balance sheet, which burdens the company in this difficult situation. More precisely, the current assets of the company are just enough to cover its current liabilities and its net debt ($27B) is about 13 times its annual earnings. The great leverage in the balance sheet burdens the earnings of the company, as is evident by the fact that the interest expense (excluding a special charge) eats 20% of the EBIT of the company. The company mentioned in its 10K Form that its debt coverage ratio deteriorated by about 23% in 2013 vs. 2012, from 6.1 to 4.7. As the average interest rate of its debt is about $1.1 B (last year's figure), one wonders how the company will keep paying $1.3B in annual dividends while it earns just $2B. In simple words, the retained annual earnings of about $0.7B are not sufficient to cover the annual interest expense of $1.1B, which means that more debt is about to be issued.

Moreover, the company incurred a "special" charge of $285 M for early retirement of a portion of its debt and it excluded it from its adjusted earnings. Unfortunately for its shareholders, there was another "special" charge of $445M last year due to early retirement of debt. Therefore, the charge of early retirement of debt is not so "special," as the excessive accumulated debt markedly burdens the company. To clear things up, I don't believe that the company will face any solvency problems or it will cut its dividend. However, I do believe that a weak balance sheet makes things much worse when so many unfortunate conditions (data breach, expansion in Canada, heated competition) coincide.

To sum up, I have not seen a single positive sign in the performance of the company in the last 12 months, and hence I expect more pessimistic guidance for this year's earnings from the management in the next few weeks.

Source: Target: The Gist Of The Earnings Report