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Summary

  • Target posts second quarter results which are largely in line with expectations.
  • The company lowers the guidance for the third and fourth quarter.
  • Investors are happy with the incremental improvements in the key US market as Canada remains problematic.
  • Dividend offers appeal for income-seekers, prospects for short term capital gain is limited in my eyes.

Investors in Target (NYSE:TGT) were relieved with the company's results. While the second quarter results were largely in line with expectations, investors were relieved by improving trends throughout the quarter despite a downwards guidance for the full year which has largely been anticipated.

Canadian problems continue to haunt the business, as the key US business is showing signs of a small improvement. While I like the dividend, the current prospects for medium term capital gains is limited in my opinion.

Main Points For The Second Quarter

Target posted second quarter sales of $17.41 billion which is a 1.7% increase compared to last year as reported. Revenues came in slightly ahead of consensus estimates around $17.3 billion.

On the bottom line a profit of $234 million appeared, a 61.7% reduction from last year. Amidst a tiny reduction in the outstanding share base, earnings per diluted share were down by some 61% to just $0.37 per share.

Looking Into The Results

Target's results are of course still impacted by the data breach as well as the terrible expansion trajectory into Canada.

US sales rose by 0.7% to $17.0 billion amidst store openings with comparable store sales being flat compared to last year. The number of transactions fell by 1.3% being made up for by increased pricing.

Operating EBIT margins fell by 110 basis points to 6.8% of sales amidst a full one percent reduction in gross margins amidst higher markdowns related to an increased promotional environment. The company managed to cut selling, general and administrative costs by some 20 basis points to offset some of this margin pressure.

CEO John Mulligan was quite upbeat about the US operations with traffic trends improving throughout the quarter, driving a 1% increase in comparable sales for July. This momentum continued into August with the early results from the important back-to-school season pleasing executives.

Canada remains a very problematic story despite headline sales increasing by 63.1% to $449 million. All and some more of this growth was driven by new store openings with comparable store sales being down by 11.4%. The unit lost $204 million on an operational basis which compares to a $169 million loss as reported last year. The company is continuing to address the issues, aiming to make the most of the upcoming holiday season.

Gross margins were down by 13.2% to just 18.4% of sales which are very poor margins for any kind of retailer frankly. Greater scale was becoming apparent in selling, general and administrative expenses which fell nearly 27 percent points to 48.3% of sales. Overall, the Canadian business remains in a very problematic shape.

In term of the reported GAAP earnings, a whole range of items impacted the past quarter's profitability of the firm. Pre-tax data breach charges totaled a $111 million or $0.11 per share for the quarter, as Target is hopeful that the vast majority of costs related to the breach are now covered. Furthermore the early retirement of debt cost another $285 million, or $0.27 per share.

Adjusted for these and some other small items, profits came in at $0.78 per share which still marks a twenty cent decline in earnings per share compared to last year. Despite the earnings shortfall, earnings were in line with consensus estimates.

Lowering The Guidance

For the current third quarter, adjusted earnings are seen between $0.40 and $0.50 per share, which actually marks another sequential decline in earnings which is typically occurring in the third quarter given the seasonality of the business. Analysts anticipated third quarter earnings of $0.66 per share on an adjusted basis.

Full year adjusted earnings are now seen between $3.10 and $3.30 per share, which compared to the company's previous guidance for earnings of $3.60 to $3.90 per share. Note that the business reported $1.48 in adjusted earnings so far this year, which implies that fourth quarter earnings could come in between $1.17 and $1.37 per share. Analysts already anticipated Target to reduce its full year outlook, with annual consensus estimates standing at $3.44 per share.

The company has identified a lot of one-time costs, especially recognized in the second quarter, which total $0.48 per share and will impact the full year GAAP earnings.

A Look At The Valuation

At the end of the quarter, Target held some $800 million in cash and equivalents while its total debt position came in at $14.2 billion which results in a $13.4 billion net debt position.

With some 638 million diluted shares outstanding, and those shares currently trading around $60 per share, investors currently value Target's equity at some $39 billion.

On a trailing basis, Target has now posted sales just north of $73 billion on which it has posted earnings just above $1.5 billion. Of course, reported GAAP earnings have been hit hard by one-time items mainly as a result of the data breach.

A History Of Solid Growth, But What About The Recent Stagnation?

Between 2005 and the anticipated results for this year, Target has increased its annual revenues by little over 50%, growing its topline at 4-5% per annum. While this is decent, revenues have been flat in 2012 and 2013, not anticipated to show much growth this year.

Earnings have not grown as quickly, coming in between $2-$3 billion in each of the years over the past decade. Net profits are expected to fall below $2 billion on a GAAP basis this year, but are seen around $2 billion on an adjusted basis.

The shortfall in recent earnings of course relates to the data breach which the company is leaving behind, yet worries about Canada continue to be very real. Operating losses in Canada cost the company close to a billion per annum. While the company is making very slow progress, this is still quite unsubstantial compared to the current losses.

Final Recommendation

Of course Target has major issues and while the data breach is gradually becoming a thing of the past, the issues in Canada certainly are not as earnings have stabilized or improved just very slightly at best.

Given the issues, adjusted earnings of about $2 billion are the maximum attainable at the moment which is not that much in relation to a nearly $40 billion equity valuation. Also take into account that Target has quite some debt. Yet if the company can break-even in the country, earnings could improve towards $3 billion per annum making the valuation quite a bit more attractive.

As such investors have not been panicking, with shares being down just 15% since the levels around $70 in the summer of last year. That move is relatively modest given the huge losses in Canada and the big impact from the data breach. Part of this modest retreat is of course thanks to a recent dividend hike with the company now paying $0.52 per share on a quarterly basis. This provides investors with a 3.5% dividend yield.

As such the company is pleasing investors through fat dividends as its new CEO is working through the issues in Canada for which the company still has no grand plan other than incremental improvements. Those with patience can continue to hold onto the shares, cashing in nice dividends in the meantime. Yet the real immediate appeal is gone in my eyes after the recent jump from the mid-fifties in recent months to levels above $60 by now.

Source: Target - Optimism About Core U.S. Business Provides Comfort Among Continued Canadian Turmoil