Update: Target Continues To Disappoint

Aug.21.14 | About: Target Corporation (TGT)

Summary

Target reported weak earnings with flat comps in the US and double-digit declines in Canada.

Canadian operations continue to be a drag on earnings.

The stock remains 25% overvalued even assuming a return to comp growth and growing margins.

In my article on 6/20, I argued that Target (NYSE:TGT) was overvalued even after having trailed the market over the past year. In my valuation model, I assumed that Target would resume growing same-store sales at a healthy clip, rein in on unprofitable store expansion and grow gross and operating margins moderately. Under those assumptions, I arrived at a fair market value of $47, which is a discount of around 20% to the current stock price.

Business performance

Target's Q2 results were much weaker than my expectations. In Q2 FY14, sales grew only 1.7% while comps were flat in the US and down 11.4% in Canada. Operating income (EBIT) declined 12.8% in the US, driven by a decline of 1 ppt in gross margin YoY. Gross margin for its Canada stores was 18.4%, a steep decline from 31.6% last year driven by inventory clearance. Year to date gross margin is tracking at 29.7%, exactly in line with my valuation model. SG&A expenses are at 21.5% of sales YTD, also higher than my assumption of 21%.

Valuation update and summary

Based on Target's updated guidance, I am lowering my revenue growth expectations from 5.2% to 3.1% for FY14, which still assumed a healthy second fiscal half. I am also increasing the SG&A spending for FY14 to 21% of sales, up from 20%. I am leaving my assumptions around 2.5% same-store sales growth from FY15 on unchanged. My updated assumptions results in an outlook of $3.2 in EPS for Target for FY14, which is in the mid-point of guidance. My fair market value decreases from $47 to $45, indicating that the stock is still pretty overvalued. I would strongly recommend against buying at these prices.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Additional disclosure: I am short TGT $45 and $40 puts.