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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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As always, feel free to ping us with any follow-up questions.

 

Best of luck out there,

 

DD

 

Darius Dale

Director


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The Macro Show Replay | August 19, 2015

 


CHART OF THE DAY: Have You Seen This E-Commerce Chart? (Change Happens Slowly, Then All At Once)

Editor's Note: The chart and excerpt below are from this morning's Early Look written by Hedgeye Retail Analyst Alec Richards. Click here for more info on how you can become a subscriber. 

 

...To borrow a Keithism – change happens slowly, then all at once. It was as true for Plante and the goaltending profession as it is for the retail industry. That’s never been more clear than it is today with the proliferation of e-commerce. To throw some numbers into the equation, the top 500 retailers on the internet generated $297 bil in sales in the US in 2014, almost 2.5x the $126 bil number posted in 2009. Good for a 19% CAGR. And it doesn’t appear to be slowing down as consumers continue to shift their spending behavior to the web.

 

CHART OF THE DAY: Have You Seen This E-Commerce Chart? (Change Happens Slowly, Then All At Once)  - z cod E comm sales


The Mask

"How would you like a job where every time you make a mistake, a big red light goes on and 18,000 people boo?"

-Jacques Plante

 

Pure poetry from a man who made a living taking vulcanized rubber off the kisser. For those of you who are not familiar with Jacques, he’s got enough Stanley Cup rings to fill a full fist, a plaque in the Hockey Hall of Fame, the 6th most wins in NHL hockey history and 7 Vezina Trophies (during his time it was given to the goalie with the best Goals Against Average). While his resume and verbiage could rival that of Jordan and Poe by far his biggest contribution to the sport was the permanent introduction of the goalie mask to the NHL.

 

The Mask - z jacq

 

The story of the mask’s inception is entertaining in its own right, but the resistance to change might be the better proverb to share. Plante had lobbied his coach Toe Blake (2nd most decorated coach in NHL History) to wear the mask prior to the 1959 season, but failed to gain permission due to obstructed vision and bravery concerns. On November 1st while playing a tilt at MSG, Plante took a slap shot to the face that required a good amount of cosmetic work to fix, and refused to reenter the game (there were no backup goalies) without a crude looking piece of molded fiberglass to protect his face.

 

The Canadiens won that night and the next 17 tilts before Toe Blake had his way and forced Plante to remove the mask. The Canadiens lost that night, and the goalie mask has been a staple of goaltender paraphernalia ever since.

 

Back to the Retail Grind

 

To borrow a Keithism – change happens slowly, then all at once. It was as true for Plante and the goaltending profession as it is for the retail industry. That’s never been more clear than it is today with the proliferation of e-commerce. To throw some numbers into the equation, the top 500 retailers on the internet generated $297 bil in sales in the US in 2014, almost 2.5x the $126 bil number posted in 2009. Good for a 19% CAGR. And it doesn’t appear to be slowing down as consumers continue to shift their spending behavior to the web.

 

That’s all well and good, but we have to say that we don’t envy retail CEOs who must now, like Jacques, sit in front of the ‘red light’ and navigate business models that were built for an entirely different generation of commerce.

 

The best example of that is our top short idea in the retail space – Kohl’s. The apparel retail concept was a cult stock back in the mid-90’s as the alternative to shopping at a regional mall. People could avoid the crowds as well as the 20-30 minute drive, and instead could drive 10 minutes to a local strip-center where they could buy decent brands at a decent price. The problem now is there is a new alternative and it’s called the internet.

 

The company has invested arguably too much capital to build a $2bil e-commerce business from scratch over the past 10 years for a business that a) has gross margins 1200bps below a traditional brick and mortar sale, and b) brick and mortar comps have been negative in 14 of the last 15 quarters as e-commerce has been anything but incremental. What’s the alternative? Lose market share at an accelerating rate.

 

We remain convinced that there are underappreciated risks (e-commerce is just one of them) to this model that will keep the company’s realized earnings power below $4.00 – pretty much forever. That’s notable when the Street is building up to a $6.00 EPS number over four years. If our numbers prove right then we’re probably looking at about an 11-12 multiple on $3 in earnings – or about $35.

 

As much as KSS is a loser, there are plenty of winners out there. Consider Restoration Hardware. While KSS is saddled with a legacy infrastructure built for an increasingly economically irrelevant generation, RH is recreating its store base for the next generation’s core spending demographic.

 

Yes, much of the growth profile of the company is based upon 30%+ square footage growth as the company blows out its real estate profile with 50,000 square foot stores as opposed to the legacy 8,000 foot stores (that were too small – only able to showcase 10% of the company’s product).

 

But answer me this…if a person buying a $3,000 sofa visits the showroom 3x, and then makes the purchase online – is it a store sale, or an internet sale? We really don’t care, and neither does Restoration Hardware. They call it profit, and we call it outsized stock performance.  That’s why nearly 50% of its sales come through via internet – the highest in retail second only to Amazon.

 

By 2018, we’re looking at $11 per share in earnings for RH in 3-years’ time, which compares to the consensus at $6.00. Yes, we’re 80% above consensus. If we’re right, this should be a $300 stock. That’s why we won’t buy the argument that the stock is ‘too expensive’. It’s the same reason why we cringe when people say KSS is ‘too cheap’.

 

When all is said and done retailers who are able to build a scalable model harnessing the power of both brick and mortar and the internet while driving sales and profits won’t be hearing the boos.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.14-2.24%

SPX 2071-2107 

VIX 12.31-14.81 
Oil (WTI) 41.01-43.28 

Gold 1081-1130 
Copper 2.26-2.35

 

Best of luck out there today,

 

Alec Richards

Retail Analyst

 

The Mask - z cod E comm sales


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