TGT | Changes on the Margin

Takeaway: We liked this TGT print a lot. But on the flip side, it’s ‘game time’ as it relates to TGT growing its business organically.

Conclusion: We liked this TGT print a lot, and thought that Cornell & Co had the most cohesive and convincing presentation we’ve heard from any Target Management team since Steinhafel’s regime was actually executing nearly a decade ago. We’ve been short Target since last year, and it’s been flat-out painful (ie we’ve been wrong) – particularly given that we’ve been mostly right on the fundamentals. On the margin, we definitely feel more comfortable with the management team and new changes in the C-Suite. We also like how expenses are tracking, as TGT is keeping costs low while they’re starting to balloon at other retailers (check out TJX’s 800bp ramp in SG&A growth over 3 quarters). But on the flip side, it’s ‘game time’ as it relates to TGT being at a point where it needs to grow its business organically. That’s an area where we can’t give the company a free pass. We’re going to hang onto our short position for now, and will wait to see how the consensus comes in after the print. There’s a lot of moving parts this quarter. If estimates look doable, then we’re out. We’ll be back in the coming days.

 

What We Liked:

  1. The headline 10% beat and accelerating comps at the store and consolidated level on a 1 and 2yr basis is a good setup for TGT in 2H. But, and this isn’t new news, we have to see an acceleration in the underlying comp from 1.2% to 2.7% in the 4th quarter to meet current expectations. TGT has some Gross Margin dollars to work with which would help if it needs to tap the promotional well, yet this isn’t about 1Q of tough comps it’s about continuing to deliver sales results on an organic basis now that the brunt of the data breach is in the rearview.
  2. TGT bought back $675mm in stock during the quarter and is ahead of the $2bil pace management guided to for the year. This is the first quarter in the past 6 where the company retired shares and there is a $1.2bil in cash that will be added to the balance sheet at the close of this year from the announced CVS transaction that will give TGT more flexibility when it comes to financial engineering (it could buy back 2.3% of shares outstanding at $80).
  3. SG&A made up the majority of the beat as it was only up 0.3% vs last year. One major item was incentive comp, which was (deservedly) up $70mm from last year, SG&A was down 1.6%. There was about $50mm in marketing spend that was ‘pushed’ into 3Q – though we’re not sure that wasn’t just a way to keep estimates lower. Nonetheless, the SG&A control when we’re seeing such major pressure at players like WMT and TJX is commendable.   

What We Disliked:

  1. E-commerce decelerated materially from the 37% number posted in 1Q to 30% and was 1000bps below the company’s multi-year growth targets of 40%. The 3% annual sales growth guidance is predicated on +1% store comps AND 40% DTC growth. We have a hard time getting comfortable with that especially in the context of what we’ve seen across the mid-tier space. At that level of growth we think it’s safe to assume some cannibalization. TGT will need to prove that it can accelerate the pace of its e-comm channels as comps continue get tougher and the base gets bigger.
  2. What stands out to us after both the TGT and WMT print is how dependent both models are on the revenue line. When all is said and done for the year at a 2% comp to get to the top end of guidance we need to assume that...
    • Gross margin comes in at 29.7% above the long term target of 29.5%
    • SG&A straddles the long term range of 19.5% to 20% at 19.8%
    • EBITDA margins hit 9.9%  -- 10bps of the top end of the long term guidance range.

 


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