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Takeaway: Closing Canada from a position of strength. Good move. But if former mgmt. could be so off on this call, what else could be buried here?

Target just announced that it is exiting Canada. Some conclusions…

  1. The market had been expecting this. It’s part of what drove the stock up from $60 to $75 over three months. Nonetheless, it’s clearly good news for TGT.
  2. We outlined in our Black Book in May 2014 why Target would likely never earn money in Canada – counter to the company’s goal for earning $0.80 per share from Canada by Jan 2017. In this release, TGT said it’s clear that Canada would not be profitable until at least 2021. How a company could miss a profitability forecast by 4+-years is simply astounding.
  3. This decision was an easy one for new management. But if the old guard could have been so incompetent, how can we possibly believe that the decision to exit Canada is the last problem Cornell will uncover? Fixing Steinhafel’s mistakes could get expensive.
  4. The timing of this decision makes sense, as new CEO Brian Cornell has been in his seat for 5 months, and TGT is guiding to a 3% comp for the fourth quarter, which is about 50bps better than consensus. He’s making this move from a position of strength, which makes all the sense in the world to us.
  5. But let’s not forget the reason why TGT entered into Canada in the first place. First it exhausted the ‘Tar-Jay’ brand allure by turning 65% of the stores into P-Fresh (glorified supermarkets), converting 20% of its sales to its Red Card, and shifting the mix disproportionately away from Apparel, Home and Hardlines in favor of Food and Household Essentials (see below). In effect, TGT began to look a lot more like Wal-Mart.  With a strategically flawed Store and Brand transformation putting TGT up against four different competitive sets – 1) WMT, 2) Department Stores, 3) Dollar Stores, and 4) Supermarkets – not to mention Amazon growing stronger by the day, TGT’s answer was to go to Canada to find growth. Now that it found out the hard way that it was wrong, it does not mean that the factors that caused it to go North of the border have abated.  In fact, if we really are at the tail end of a retail margin cycle, which we think will become evident in 2015, then a dominant positioning in its core market is as important as ever.

Though we were right on the fundamentals with this one, that clearly did not matter – and most importantly we were definitely wrong on the stock.  Rather than rush to cover today, we’re going to a) wait to hear what the company says on the conference call, and b) see where expectations shake out. The reality is that TGT is trading at 16x-17x 2015 EPS (assuming 2-3% comp). Aside from the fact that this is a peak multiple for TGT. It seems high to us for a levered company that has its weakest competitive positioning in a decade, and is likely to grow earnings at a sub-5% rate for the next three years. This name should hardly run away from us on the upside.

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