BIG - Downgrade from Buy to Hold
TGT - Upgrade from Hold to Buy
The discount store sector is a crowded place with bulk stores, dollar stores, giant supermarkets, and close-out retailers. The space, though, continues to offer value and opportunity in some stocks. Others, however, seem to have lost their step right now. We have upgraded Target to Buy, while downgraded Big Lots to Hold. We increased our expectations for TGT but dropped our expectations for BIG. Target's latest earnings report was very strong as the company increased their operating margin for the year to 7.8% from 7.6% for 2011.
We increased our expectations as the company's profitability is outperforming what we were expecting for the company as well as increased our overall revenue expectations with the success of the CityTarget idea that we believe can be another market for Target that will allow them to open more stores in urban areas with even better margins than they have at their giant superstores. The company seems to have got their footing back after a rough 2011 as the company has moved back to appealing to their core audience with ideas like CityTarget, P-Fresh (adding produce to the stores), and less focus on slashing prices at whatever cost to attract customers that would typically shop at Wal-Mart (NYSE:WMT).
Where Target has been strong, Big Lots has been very weak. The closeout retailer has been getting crushed from two sides - dollar stores and bulk stores. The company is able to offer low-priced goods that appeal to cost-cautious spenders, but the problem is that dollar stores often offer better deals. At the same time, BIG cannot work on the same scale as bulk stores. What appeared to be a promising name coming out of the Recession seems to have lost its way in the somewhat better economy. The company's latest report was a disaster as margins shrunk and growth was much less than expected.
We drastically dropped our target for the year by over $100M for operating income and by about $50M-$75M for the next four years. Even with these drops, the company has lost a lot of value, and it is appealing below $30 as the future PE has now dropped below 10.
Outlook looks pretty solid for TGT while a bit murky for BIG. Target raised its profit outlook in the latest quarter as groceries are helping the company grow profits. The company now believes they can make 4.40 on EPS vs. earlier estimates of 4.30. That jump in outlook had a lot to do with our increase in expectations. BIG, on the other hand, cut their guidance for the full year as it seems that their product portfolio is just not selling as well as they would like. The company noted they would try food stamp acceptance as well as more coolers/freezers to add food items. Yet, the company seems a bit unsure right now of the right products to offer as they are getting hit by dollar stores and bulk stores on both sides, signaling weakness.
As we can see, BIG has had some severe declines in margins. The company commented they had to slash prices drastically to sell products, which hurts operating margin. Until BIG rights their ship, margins should remain strained, causing share prices to remain undervalued. Target outpaced in operating margin through the first half of last year, but the second half of the year hurt the stock. We believe the company is well set to do better in the second half of the year. Additionally, ROE is increasing, which is a crucial profitability indicator.
Discount and variety stores tend to offer lower value due to their lower low-growth rates that can only provide so much premium to share prices. That's the reason you have seen such an explosion in dollar store valuations for companies like Dollar Tree (NASDAQ:DLTR), Family Dollar (NYSE:FDO), and Dollar General (NYSE:DG). BIG is definitely underpriced even with its struggles, while TGT is fairer priced for the industry. Both represent value, and BIG is a good value play on a dip below $30.
Growth is fairly tepid for both companies on the sales side due to size and capacity for growth. Target ranked 8th and Big Lots 9th on our growth section of the Discount Store EquityAnalytics. For TGT, we are looking for 5-8% growth in operating income for the next few years, which will be a bit higher due to its move into Canada. BIG, on the other hand, is going to see a contraction in earnings this year, but it does set up for some nice YoY growth in 2013. From there, we are looking at around 5-6% earnings growth through 2016.
Neither company scored extremely well on financial health with TGT at 8th out of 12 and BIG at 10. TGT's ratios meet our healthy standards, but the company does have a higher debt-to-equity ratio than we would like to see at 1.0, meaning for every dollar of debt the company has, they only have 50 cents of shareholder equity. At the same time, they have good quick/current ratios for a company of their size and makeup. BIG does have a risky current ratio at 0.1, and they have added on more debt recently, which is another negative.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.