Target (TGT, Financial), the $36 billion discount store retailer, updated its outlook for its fourth-quarter and full-year earnings in early January. Target is expected to deliver the results on Feb. 28.
Among other figures that were updated on the outlook was Target’s lowering of its initial GAAP earnings per share (EPS) outlook for the full-year 2016 down to a midpoint of $4.62 per share from $4.77, or a 3.1% reduction.
Shares of the retailer fell 5.8% while the broader Standard & Poor's 500 index went up 0.18% at market close post announcement.
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"While we significantly outpaced the industry's digital performance, the costs associated with the accelerated mix shift between our stores and digital channels and a highly promotional competitive environment had a negative impact on our fourth-quarter margins and earnings per share.
“Despite these challenges, we are positioned to deliver full-year adjusted EPS1 of $5.00 or more in 2016, which would mark an all-time high for Target. And, importantly, our team has made substantial progress in positioning Target for long-term success by improving the shopping experience both in stores and on Target.com, transforming our supply chain and technology to support every way our guests want to shop and developing new store formats that allow us to reach new guests in dense urban and suburban markets.” – Brian Cornell, chairman and CEO of Target
Earnings performance
Target delivered its third-quarter and nine-months operations results in November. For the three quarters Target operated, sales fell by $3.4 billion to $48.8 billion, and profits were almost flat or had a near 1% loss to $1.92 billion compared to the same period the year earlier.
Despite the performance, shares of Target rose 6.4% on heavy volume that day while the broader S&P 500 index closed with -0.2% change.
As observed, Target was able to limit its cost of goods sold for the period – reducing it by 7.3%Â – and also the company’s selling, general and administrative expenses by 9.3%.
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“We are very pleased with our third-quarter financial results, which reflect meaningful improvement in our traffic and sales trends and much stronger-than-expected profitability.
“Favorable gross margin mix and efficient execution by our team drove third-quarter EPS performance well beyond our guidance. We also continued to gain market share in key Signature Categories and saw unexpectedly strong sales in the back-to-school and back-to-college season. As we move into the biggest quarter of the year, we are pleased with our inventory position and confident that our team will deliver a great guest experience as they bring our merchandising and marketing plans to life throughout the holiday season.” – Brian Cornell, chairman and CEO of Target
Valuations
Target shares are currently fairly attractive compared to its peers in terms of earnings multiple. According to GuruFocus data, the retailer had a trailing price-earnings (P/E) ratio of 11.5 times (industry median of 20), price-book (P/B) ratio of 3.2 times (industry median of 1.8) and price-sales (P/S) ratio of 0.5 times (industry median of 0.5).
Target also had a trailing dividend yield of 3.6% with a 42% payout ratio and a 20.6% five-year growth rate. The retailer also has been actively buying back its shares representing a 3.2% share buyback ratio.
Target is included among the list of Dividend Aristocrats and would be on track to increase its payout for the 50th straight year in 2017.
Total return
According to Morningstar data, Target underperformed the broader S&P 500 index consistently both in the short and long term having total returns of -8.96% in one year and 6.97% in a five-year period, despite being a Dividend Aristocrat.
(10-K, Target)
Target
Target was founded 114 years ago and is now the second-largest discount store retailer in the U.S. Target offers its customers or guests everyday essentials and fashionable, differentiated merchandise at discounted prices.
Target had 1,802 total stores as of October 2016 compared to 1,792 and 1,790 stores in fiscal 2015 and 2014.
Prior to 2015, Target operated a Canadian segment representing its business in Canada. As a strategic shift in Target’s business operations, the retailer exited Canada and recorded a pretax impairment loss of $5.1 billion. Also, Target sold its pharmacy and clinic businesses to CVS Pharmacy in late 2015 for $1.9 billion.
Comparable sales
(10-K and 10-Q Filings, Target; 2)
According to company filings, comparable sales is a measure that highlights the performance of Target’s existing stores and digital channel sales by measuring the change in sales for a period over the comparable, prior-year period of equivalent length.
Overall, Target had five-year sales and profit growth and operating margin averages of 1.8%, 2.9% and 7%.
Cash, debt and book value
As of October, Target had $1.23 billion in cash and $12.8 billion in debt with a debt-equity ratio of 1.16 times compared to 0.96 times the year prior. Target carried no goodwill nor intangibles in its assets and had a book value of $11 billion compared to $13.3 billion in the same period last year.
Cash flow
(10-Q, Target)
Target’s cash flow from operations fell by 25% to $2.88 billion for its nine months of operations in 2016. The decline in cash flow would have been mostly secondary to marked reduction, or 93% reduction, in Target’s accounts payable and accrued liabilities.
Capital expenditures were $1.18 billion leaving Target with $1.7 billion in free cash flow compared to $2.7 billion the year earlier period.
Target also allocated 238%, or $4.05 billion, in dividends and share repurchases – shareholder payouts –Â in its recent nine months of operations. On average, Target used 78% of its free cash flow in shareholder payouts in the past three years.
(10-Q and Morningstar Data, Target)
As observed, Target has been exceeding its free cash flow in supporting dividends and repurchases in the recent period between 2015 and 2016.
Target reduced its debt by $559 million, net long-term debt and commercial paper issuance.
Conclusion
Recent declining sales should probably cause some worry to most conservative investors. However, Target seemed quick to recognize its challenges as it had managed to deliver consistent profitability. Maneuvering the company’s business operations should not be easy for retailers this size.
Meanwhile, Target’s balance sheet seems to have deteriorate a little in recent times as it appeared more on a leveraged state than previously. The retailer’s cash flow as well demonstrated inspiring payouts to its shareholders although its cash flow per se was not able to support the billion-dollar handouts.
(Target Share Price at $63.75 per share with a trailing P/E ratio of 11.5 times, GuruFocus)
In late January, Goldman Sachs downgraded Target shares to a sell from hold while Stifel reiterated a hold with a target price of $72 a share or 15.6 times its 2016 eps outlook.
Historical earnings multiple average applied to Target’s 2016 outlook with a 20% margin gave a value of $64 per share.
In summary, Target is a hold with a target price of $65 per share.
Notes
- 10-K: Continuation: “Comparable sales include all sales, except sales from stores open less than 13 months, digital acquisitions operating less than one year, stores that have been closed and digital acquisitions that we no longer operate. Pharmacy and clinic sales for the comparable period following the sale to CVS are excluded from the calculation. Comparable sales measures vary across the retail industry. As a result, our comparable sales calculation is not necessarily comparable to similarly titled measures reported by other companies.”
2. Me:
(p. 14, recent 10-Q Target Filing)
As it turned out, there was a dash line for the nine months comparable sales change figure.
Disclosure: I do not have shares in the company mentioned.
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