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TGT – New CEO Is Wrong Strategic Move

Takeaway: This CEO hire is the mother of missed opportunities for TGT. The Board balked on #TGT2.0 and went for #OldEconomy.

Well…if you didn’t know why TGT has been strong over the past month, now you know. It’s been on the verge of hiring a new CEO and someone apparently got the memo. Quite frankly, we’re very surprised and extremely disappointed by the Board’s appointment of Brian Cornell as the new CEO and Chairman. There’s nothing wrong with Cornell at face value from where we sit. But a company as well capitalized as Target has the resources to hire the best of the best. We assumed that it would. It didn’t.

 

As we outlined previously (see comments below) the company could have gone in one of two directions. 1) TGT 1.0: sustain its recent strategic acceleration to being an old economy retailer – a capital-light option that will make tweaks to the business to produce near-term earnings results, or 2) TGT 2.0: hire someone who can transform the retailer to be aligned with how consumers will actually shop over the next 5-10 years, and re-emerge as the best-in-class aspirational retailer in the US, and even globally. Capital intensive near-term, but huge potential payoff long-term.

 

In the press release, the Board snuck in a statement that ‘Omnichannel’ will be a focus for Cornell. But truth be told, ‘Omnichannel’ is a focus for just about everyone. It’s the most abused buzzword retailers have had in decades. Don’t mistake that for #TGT2.0.

 

We’re divided on what this means for the stock.  The twittersphere is already lighting up about how positive this is for TGT, and we’re seeing sell-side upgrades on the news. This is after a 11% run in the stock since the beginning of last month – which is a lot for Target.  

 

Without having heard Cornell’s plans, we’re inclined to think that he’ll be focused on near-term tactical patches to the model. At risk of sounding punitive, he has not even been in any of his four most recent executive roles for more than 3-4 years before exiting for the next opportunity. Maybe he’s looking to settle down in Minny for the long haul. A near-term focus could mitigate numbers going down further over the near-term. That’s an obvious inhibitor to a short playing out right now. But it would rob exponentially from the value that could be created in the outer years – the same value that any long-term investor would pay for today.

 

In the end, we need to see what Cornell’s plans are for this company. The market already is placing its bets that he’ll be a winner. But call it #TGT1.0, #OldEconomy – it’s all the same. This is a bad choice and a missed opportunity to make this company great again.   

 

07/24/14 08:33 PM EDT

TGT – Target 1.0 vs 2.0

 

Takeaway: If it turns out that WMT’s US CEO left to take the top job at Target, we’d look to get much heavier on the short side of TGT.

 

CONCLUSION: If it turns out that Bill Simon left his post as CEO of WalMart US to take the top job at Target, we’d look to get much heavier on the short side of TGT. We think that move would simply be disastrous for Target, and would set the company down a path that is simply uninvestable, and likely value-destroying.

 

WHY THIS WOULD BE A BAD MOVE

First off, there’s nothing wrong with Simon. The guy ran a $280bn business – nearly 4x the size of Target’s revenue base. Did WMT’s US stores knock the cover of the ball during his tenure? No. But you don’t get to be CEO of the largest division of the biggest company in the world (ranked by revenue) by being incompetent. Furthermore, Simon potentially knows more about how to collect customer data and use it to generate sales than everyone in the Target organization combined.  Ultimately, for someone who thinks that the key for TGT is to be more competitive with WMT, then this would be a massive win.

 

But TGT Needs to Become Everything That WalMart is NOT. Trying to become WalMart is what got Target into trouble in the first place. Remember in 2008 when ‘Tarjay’ was actually inked in the Urban Dictionary to memorialize Target as a place where teens went to get trendy fashion at cheap prices? Well, management had the Branding equivalent of lightning in a bottle. Yes, WalMart envied it. So did Macy’s. So how did Target answer?

  1. It converted 65% of its stores from 2008 through 2013 to P-Fresh stores. Basically, this is a Supermarket where a Soccer Mom could get Eggs, Bread, Pop Tarts, and then grab a sweater and some bed linens.
    TGT – New CEO Is Wrong Strategic Move - tgt note 1
  2. It pushed the Red Card, which gave 5% off all purchases. Over the same 2008-2013 time period, Red Card went from 5% of purchases to just shy of 20%. We’re really not worried about the direct financial impact, which is about $833mn/yr in lower Gross Profit due to higher discounts, as that realistically was offset at least a little bit by higher purchase volume. The real problem we have is with how this, combined with P-Fresh conversion changed the shopper profile.
    TGT – New CEO Is Wrong Strategic Move - tgt note 2
  3. Mix changed accordingly, with the highest margin categories like Apparel and Home Furnishings giving way to perennially low-margin Food and Household Essentials (non-food products you buy at a grocery store).
    TGT – New CEO Is Wrong Strategic Move - tgt note 3

So think about it. TGT went from cool, edgy ‘Tarjay’ where it was the envy of most of its peers, with a relatively defendable customer and would actually compete on the fringes with the likes of H&M, to being the place where a person who cares about nothing but price, or shops there simply because they hate going to WalMart. It went from having a peer group where it had a notable competitive advantage, to putting itself right in the middle of four unique competitors – 1) WalMart, 2) Department Stores, 3) Dollar Stores, and 4) Supermarkets. As a bonus, it has Amazon.com hovering over its head plucking away every last sales dollar it can.

 

Oh, and by the way, once TGT realized this was a multi-year string of horrible decisions, it decided to look to a new venue for growth – Canada. We have a whole deck quantifying why that’s flawed. But by now that’s hardly an out-of-consensus view.

 

Our point is that this whole mess is why Steinhafel was fired as TGT’s CEO. It wasn’t due to the data breach. Maybe the breach was a good excuse, or a catalyst, for the Board. But it was not the reason for ousting him.

 

This brings us to why hiring Bill Simon as TGT’s CEO would be a very bad idea.

All of Target’s missteps over the past six years are a product of what we’d call ‘Retail 1.0’.  Simon is the zen master of Retail 1.0. Unfortunately, upgrading to Retail 2.0 is the only thing that can save Target now, and we seriously doubt that Simon could do it. Importantly, if the Board hires him, then it shows us that it is content with Retail 1.0. That’s a multiple-compressing event, over time.

 

We don’t think that Target 2.0 will be achieved by rolling back the clock to try and recapture the string of excellence it had in the 2000s. That’s actually borderline impossible. It would be like taking a pickle and trying to make it a cucumber again.

 

It really needs someone to step in and change the paradigm. Target has tremendous assets – in its store base, logistics network, and (too many) people. The Board should not be looking at McMillon’s team at WMT for a new CEO, but instead should be looking at Jeff Bezos’ team at AMZN. That’s the place/culture to look for a winner that could not only fix Target’s dot.com business, but make it a Brand that anticipates where and how consumers will shop 5-10 years down the road.

 

What This Means For The Stock.

1) We’re going to give the TGT Board the benefit of the doubt on this one. We think that it is looking for a CEO who can make sweeping changes to create considerable shareholder value 4-5 years out (i.e. Target 2.0). We also think that anyone who takes on that challenge will make sure that he/she has the Board’s buy-in to spend the considerable capital needed to change this company so dramatically. Ultimately, we think that this could lead to TGT being the best performing stock in the S&P – in about 2019. Until then, it will be extremely slow and painful, and earnings and cash flow assumptions out there will prove to be way to high. For the record, this is similar to what we said about JCP when it was at $40.  TGT could get cut in half under that scenario.

 

2) Scenario 2 is a little tougher. This is the Target Board sticking with Target 1.0. That means that we could see the stock pop on the news, like with any scenario, and that the new CEO will be making tweaks to boost near-term cash flow and earnings. That might take numbers higher, but it will seriously dampen the potential for any real growth in this business. Then you’re playing for a levered, low-growth retailer in year six of a retail margin expansion cycle – something we’ve never EVER seen go into year seven.

 

We still like the risk-reward on this one – a lot. 

TGT – New CEO Is Wrong Strategic Move - tgt note 4

 



YUM: WARNING SHOTS FIRED

YUM: WARNING SHOTS FIRED - 1

 

YUM filed an 8-K yesterday after the close, in which it discussed the recent food scandal involving supplier Shanghai Husi, a division of OSI.  The company has since terminated its relationship with OSI globally, but severe damage has been done. 

 

According to the company:

  • "While OSI was not a major supplier to Yum! Brands, these events triggered extensive news coverage in China that has shaken consumer confidence, impacted brand usage, and disparaged the hard work of our over 400,000 Chinese employees."
  • "The result has been a significant, negative impact to same-store sales at both KFC and Pizza Hut in China over the past 10 days."
  • "At this point, it is too early to know how quickly sales will rebound in China and the corresponding full-year financial impact to Yum! Brands."
  • "However, if the significant sales impact is sustained, it will have a material effect on full-year earnings per share." 

 

Recall that on July 23, 2014, we removed long YUM from our Investment Ideas list (YUM: Losing Faith) on the basis of a significant, anticipated setback in China following the initial report of improper food handling practices in the country.  Chinese consumers are still fragile and, as we opined, the consequences of this event would be material.  As it stands, we believe consensus full-year same-store sales (depicted in the chart below) and earnings estimates are far too aggressive.  We won't know much more until the company reports 3Q14 results in October, but this is a name we'd stay away from.

 

YUM: WARNING SHOTS FIRED - 2

 

Call with questions.

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst


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EUROPE SLOWING TOO?

Client Talking Points

EURO

Is the U.S. Dollar strengthening because the U.S. economy is, or is it signaling immediate-term TRADE overbought versus the EURO because Europe is slowing now too? We’ll take the latter – because the early cycle growth components of everything from the Russell 2000, Housing, and UST 10YR Yield are.

GERMANY

We see bearish @Hedgeye TREND signals across European Equities  - and while the DAX is down the least (compared to Portugal -1.6%, Spain -1.3%, Italy -1.1%) this morning, at -0.7% to 9523, it’s well below our 9788 TREND resistance line.

UST 10YR

Newsflash: One up-day to lower-highs within a bearish TREND for U.S. 10yr yields doesn’t a new bear market in the long bond make. 2.54% 10yr yield within a 2.44-2.56% immediate-term risk range. We reiterate our #Q3Slowing USA theme this morning.

Asset Allocation

CASH 32% US EQUITIES 4%
INTL EQUITIES 16% COMMODITIES 12%
FIXED INCOME 26% INTL CURRENCIES 10%

Top Long Ideas

Company Ticker Sector Duration
HOLX

Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration.  The first survey tool measures 3-D Mammography placements every month.  Recently we have detected acceleration in month over month placements.  When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner.  With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds. Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.

OC

Construction activity remains cyclically depressed, but has likely begun the long process of recovery.  A large multi-year rebound in construction should provide a tailwind to OC shares that the market appears to be underestimating.  Both residential and nonresidential construction in the U.S. would need to roughly double to reach post-war demographic norms.  As credit returns to the market and government funded construction begins to rebound, construction markets should make steady gains in coming years, quarterly weather aside, supporting OC’s revenue and capacity utilization.

LM

Legg Mason reported its month ending asset-under-management for April at the beginning of the week with a very positive result in its fixed income segment. The firm cited “significant” bond inflows for the month which we calculated to be over $2.3 billion. To contextualize this inflow amount we note that the entire U.S. mutual fund industry had total bond fund inflows of just $8.4 billion in April according to the Investment Company Institute, which provides an indication of the strong win rate for Legg alone last month. We also point out on a forward looking basis that the emerging trends in the mutual fund marketplace are starting to favor fixed income which should translate into accelerating positive trends at leading bond fund managers. Fixed income inflow is outpacing equities thus far in the second quarter of 2014 for the first time in 9 months which reflects the emerging defensive nature of global markets which is a good environment for leading fixed income houses including Legg Mason.

Three for the Road

TWEET OF THE DAY

Former CEO of PepsiCo Americas Foods, Brian Cornell, is named as new CEO and chairman of the board of Target.

@HedgeyeStaples

QUOTE OF THE DAY

Creativity comes from trust. Trust your instincts. And never hope more than you work.

-Rita Mae Brown

STAT OF THE DAY

Another solid session for Chinese stocks, Shanghai Composite up +0.9% to +7.2% year-to-date.


CHART OF THE DAY: GDP Newsflash, It's Q3

To be fair to the 2014 US Growth Bulls who are looking for +3-4% GDP and a 10yr Yield > 3%, with a Q2 +4% bounce off of one of the worst Q1s since WWII on an annualized basis, 1st half of the year GDP in the US wasn’t negative. It was +0.87%. 

CHART OF THE DAY: GDP Newsflash, It's Q3 - Chart of the Day


Newsflash, It's Q3

“For a fee, the exchange will flash information.”

-Michael Lewis

 

That’s a simple quote (from Flash Boys, pg 44) to a simple problem that RBC’s Brad Katsuyama faced in 2009 – being run over by getting late information. This is why Raj @Galleon paid such a premium for inside information. Front-running information flow? Yep. There’s big money in that.

 

There’s also lots of moneys in not losing other people’s moneys by chasing macro headlines that are taken out of context. Yesterday’s newsy Q2 2014 US GDP report was a fantastic example of that: “US Equity Futures and Bond Yields Surge on +4% GDP!”

 

Newsflash: it’s Q3.

Newsflash, It's Q3 - GDP cartoon 07.30.2014

 

Back to the Global Macro Grind

 

To be fair to the 2014 US Growth Bulls who are looking for +3-4% GDP and a 10yr Yield > 3%, with a Q2 +4% bounce off of one of the worst Q1s since World War II (see our Chart of The Day for context), on an annualized basis, 1st half of the year GDP in the US wasn’t negative. It was +0.87%. #Booyah

 

“So”, 62 months into a US economic expansion, as the intermediate-term TREND in US economic growth slows, you want to be buying that flash of Q2 “bounce” information, right? Wrong. US Equity futures reversed in a hurry yesterday and are now indicated down another 13 handles.

 

Spooo-hoo. What else can US consumer (XLY, XLP), housing (ITB), or early cycle industrial (XLI) perma bulls blame this morning?

 

  1. Europe? Sure, most of it, actually – Italian youth unemployment = 43.7% (whatever it takes!)
  2. China? After one of its best 2-week stock market moves in 4 years, not so much
  3. How about Israel or Putin, or something like that? #BlameCanada

 

I can flash you bullish information. Manufacturing that is easy. Twitter actually made-up user information using robots! It’s funny - if we write anything remotely USA bullish an entire community seems to cling to that like we’re going to enter the next 62 month expansion without ever leaving the first one!

 

According to one reading that I would characterize as one of the best contra-indicators of late 2007 (the Conference Board’s qualitative consideration of US consumer confidence), everything is just peachy. Problem is that you sell a cyclical (the US economy) when goldilocks is feeling peachy.

 

The best 2015 bull case (sorry, it’s still 2014) for the average American consumer that I have read to-date is one that our own Darius Dale wrote about yesterday (ping for his note) – reversing the bearish #InflationAccelerating call we have had since January.

 

That thesis goes as follows:

 

  1. US Dollar rips again (after it already ripped to overbought YTD highs)
  2. Commodities collapse (like they did in 2013)
  3. And the US consumer starts spending his and her brains out

 

If only 80% of America got DD’s flash report from us in their gmail boxes this morning… The poor bastard making $48,000/year with peak all-time cost of living would wake up feeling rich again!

 

Obviously real world wages and consumption patterns don’t work that way (or did you get a rent reduction and discount at Chipotle this morning?). Markets aren’t economies either. If they were, the Argentine stock market wouldn’t have been +7% to +67.3% YTD yesterday.

 

Markets are non-linear and constantly being barraged by multiple risk factors, across multiple durations. Meanwhile investors are constantly being tested by their confirmation biases and emotions. That’s why, as I get older and fatter, I like to wait and watch.

 

I also like to ask myself a lot of questions. I genuinely enjoy reading my analysts research views too. If they are doing their job, they’re constantly in flux, weighing each data point within the context of both the last and our forward looking TREND.

 

Is the US Dollar “strong” (US Dollar Index is +0.4% over the last 6 months, -0.5% over the last year) because the US economy is strengthening, sequentially (from Q2 to Q3) or is the Euro (vs USD) simply weak because the European recovery is weakening?

 

If Europe’s recovery slows in 2H 2014 like the USA’s did in 1H 2014, what does that mean for US listed multi-national consumer staples and industrial stocks? Fortunately the answers to these questions won’t be in a “survey.” They’ll be marked-to-market, flashing as new time/price information on our screens.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.44-2.56%

SPX 1

RUT 1134-1154

DAX 9

VIX 12.21-14.41

USD 81.61-81.57

EUR/USD 1.33-1.35

Gold 1

Copper 3.17-3.27

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Newsflash, It's Q3 - Chart of the Day


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