Show-me The Comps

Target’s earnings report and conference call still leaves us comfortable with our short bias over the near-term.  In fact, it’s probably now more clear than before that the near to intermediate term topline results are integral to this show-me story.  The expected sales ramp over the course of the year, tied almost entirely to the company’s growth in P-Fresh remodels and 5% Reward penetration, is the single biggest factor in determining if TGT can control its own destiny or if macro factors will keep the topline muted.  We remain concerned that guidance for incremental comps of 200-400bps driven by such initiatives still remains aggressive. 

 

As always there were a few positives (mostly longer-term) and a few negatives to contemplate following today’s official 4Q report.  First the positives:

  •  TGT’s quarter was largely as expected following the company’s January pre-announcement that indicated credit card profits and a favorable tax rate would offset modest declines in retail profitability.  In reality what we got was a much better tax rate to the tune of $0.07 per share and a flat y/y EBIT performance from retail.  All in no big surprises in the P&L.
  • Management suggested that a sale of the credit card portfolio has become increasingly likely, although the timing of such a transaction could take time and drag into early 2012.  The transaction will result in a gain on sale and a future stream of “shared economics” between the new owner and Target.  This should viewed as a win, as this takes risk off of the company’s balance sheet while maximizing the NPV of the portfolio at a time when credit seems to be stabilized. 
  •  Additional clarity was given on Canada and the impending transaction to acquire 180-200 former Zeller’s locations/leases.  The process is clearly underway and will begin to impact the P&L in the form of front-loaded investment beginning in 2Q.  This investment covers IT development, increased headcount to support the Canadian expansion, and the assumption of leases as they become property of Target.  Store openings are still slated to take place in 2013 and 2014.  Bottom line here is this will be a drag for a while until the stores actually produce revenues.  For those with a multi-year time horizon, we believe Canada will be a success and has the potential to be a key top and bottom line driver beyond the next two years.

And the negatives:

  •  The P-fresh and 5% reward programs are clearly having an impact on the topline, although not as much as originally anticipated at this early part of the roll-out.  Management noted that the rewards program added about 100bps to 4Q same store sales and P-fresh added a bit as well.  Target now expects the two efforts to contribute about 350bps combined on a run-rate basis to same store sales by the end of the year.  Keep in mind that in late fall, the expectation was for these efforts to contribute an incremental  200-400bps for the ENTIRE year.  Yes this is a subtle change in tune, but one that at best makes 2011 a year of two distinct halves.  First half comps now expected to be positive low single digits, while the second half is planned higher.
  •  The investments in Canada will result in two buckets of costs over the course of 2011.  First the actual investment in people and infrastructure to support the acquisition, which amounts to $0.10 share.  Second, the funding for Canada is now expected to put share repurchase temporarily on hold to the tune of $0.05 to $0.10 per share.  All in a $0.15 to $0.20 per share hit in the near term.  We understand these are prerequisite investments that must be made and we like the Canada acquisition.  However, we suspect that this effort may also add additional SG&A volatility over the coming year as operating a new and sizable division in a completely new country with re-purposed real estate is sure to bring some surprises.
  •  Inventories came out of the quarter a bit on the high side, up 6% against a 2.8% in total sales growth.  Management says inventories are in good shape but we can’t ignore that the reported sales/inventory spread as at its widest point in a year.  
  •  The year’s greatest same store sales increases are now expected to occur in the back half of the year at the same time costs and pricing issues are going to be at their greatest year over year increases.  We respect management’s conservatism on holding off from predictions on how the consumer will react, but we can’t ignore the fact this boils down to increased uncertainty at time when management appears to be more confident in their own sales growth.  Time will tell.

Show-me The Comps - tgt

Eric Levine

Director