We're bearish on TGT, and think that the print on Wednesday will support that view. That is we expect softening numbers on the margin in the form of decelerating comps and negative earnings growth. With the key caveat being that expectations headed into the print are more than manageable for the company to manufacture a beat. If for some reason TGT should fail to meet what we see as the most modest/conservative expectations in the space, we’d still short on weakness as we think an earnings miss, however unlikely, is a much greater statement about this company’s competitive position now that Cornell has made the easy fixes (Canada, Rx, headcount) and the state of the US consumer. Assuming things play out the way we think they will, we’d short on strength. Regardless of the outcome tomorrow, short the news.
On the one hand, TGT has recouped all (and then some) of the market cap the company coughed up after the 2Q guide down back in May. And expectations from here are far from easy. With the Street baking in an acceleration in comps on both a sequential basis from 0.2% in 1H to 1.4% in 2H and in the underlying trend (up 30bps in the 2yr run rate). That ultimately flows through to earnings growth rate of 14% in 2H vs. 4% in 1H. If there is any risk to the print, it’s on the full year guidance, as management took a 'wait and see' approach before taking down numbers past 2Q.
But we’ll curb that prior statement by pointing out how low expectations are headed to the print up and down the P&L. Current Consensus expectations assume i) a -0.9% comp, the lowest TGT will have printed (assuming it hits the mid-point of its guide) since it lost 70mm customers’ credit card information, ii) 50bps of margin deleverage, which translates to 100bps+ of deleverage when you factor in the benefit the company is getting from the sale of its Rx business to CVS, and iii) a 7% earnings decline that’s being propped up by a share count 7% lower than it was a year ago.
The point there is that TGT was proactive three months ago when it took down numbers to a level where it could manufacture a beat in 2Q and allow the company to hold FY guidance for now, while it peddles the consumer/weather bottomed in 2Q narrative for another three months until it has to face the music of back-loaded guidance against equally tough comps.
Over the long-term, we’re not buyers of that storytelling, as we think that TGT’s competitive positioning – hello WMT and AMZN – and underinvestment relative to its competition equates to a flattish 4yr earnings CAGR compared to the Street at 11%. As we think flattish margins on a 2.5% top-line is a pipe dream. That gets us to a sub-$5.00 earnings number in 2018 vs. the Street at $6.25.
Key space considerations headed into the print…
TGT Hated, WMT Loved
We think this chart is particularly interesting given the space we allocate to the relationship between TGT and WMT in the paragraphs below. Essentially, this tells us that sentiment on TGT relative to WMT is at all-time lows. Demonstrated by a trough relative multiple (TGT 14x NTM P/E, WMT 16.8x NTM P/E) and peak short interest. At the same time short-interest ticked up to its highest rate in a half a decade. The irony is that we’d own WMT here over TGT without hesitation. The pessimism around TGT is deserved. Over the long-term, people are bearish – but not bearish enough.
Competitive Dynamics Still Evolving
Core to understanding the TGT story here is the company’s competitive placement in US retail. Currently, it’s right smack dab in the middle of very unenviable competitive set that is: WMT, Dollar Stores, Grocers, Department Stores, and AMZN. There are puts and takes on each as it relates to the TGT call, but we think the one worth focusing from a demand perspective is AMZN. And no, it’s not because TGT started stocking Kindle’s on its shelves once again.
The real callout is the overwhelming share of consumers wallets that AMZN has taken over the past 12 months. The numbers look like this…1) per the government, US retail has added an incremental $111bn added over the past 12mnths, 2) AMZN alone has accounted for 26% of the incremental growth, 3) that’s $28bn when you incorporate 3rd party sales, and 4) that’s good for the highest rate we’ve ever seen and a rate 50% higher than the company recognized a year ago.
For a company like TGT that needs perfect conditions to comp in excess of 2% in its core US business, that’s a material change to the competitive landscape.
Where’s The Investment?
Let’s take this step by step...
1) We are seeing considerable market share pressure as AMZN takes a bigger and bigger chunk of the retail pie, that’s up to 26% on TTM basis as of the latest AMZN print.
2) TGT’s biggest brick and mortar competitior, WMT, announced last year that it would open up its usually-tight pockets to invest in employees, e-commerce, stores, vendors, and, to a certain extent, price. At the same time, WMT lowered expectations to a level that meant it wouldn’t hit 2015 earnings levels again until 2019.
3) We’ve seen that play out in pretty dramatic fashion over the past 4 quarters, as WMT put its money where its mouth was in the US with SG&A/Sq.Ft. up 9% in the quarter the company reported 3 months ago. That compares to TGT, who just went negative, opening up the biggest spread in SG&A dollars that we’ve seen between the two companies in at least 3 years.
4) From here, the TGT playbook calls for the company to free up $2bn in cost savings to fund the investments needed to prop up a 3% comp. The key buckets of that investment are as follows: people (they’ve added a lot of new faces in the C-Suite alone), e-commerce, stores, grocery, infrastructure, and of course…buying back stock.
5) Not only do we think that’s the wrong strategy for a company that must now grow 100% organically, but it’s also not enough to keep pace with a competitive set who are making material and quantifiable investments needed in order to win the traffic/market share battle. The low hanging fruit for Cornell and Co. has already been picked and the easy comps have already been lapped. Ultimately, we think this plays out with TGT being the net market share loser.
WMT Throwing Down The Gauntlet…Again With Jet.com
While we think the purchase of Jet.com at ~6x sales at the tail-end of an economic cycle is a poor use of shareholder capital for WMT, the company’s newest (and most expensive) acquisition we think signals a few things to the both the market and the rest of retail – the most important being that e-commerce is the single most important growth vehicle going forward. That’s not new news by any means, but when WMT is willing to fork over $3.3bn to supplement the talent/technology in its perennially underperforming channel, it sets the investment hurdle rate that much higher for the rest of its competitive set.
That’s particularly important for a company like TGT, who like WMT, has consistently underperformed in the e-commerce channel. Heck, TGT’s dot.com sales penetration at 3.6% is within spitting distance of WMT, and it’s not like near-term execution or communication of the opportunity in that channel has been well-handled. Back in March, the management team backed off its long-term 40% e-commerce growth CAGR as well as the long-term investment needed in order to get TGT to a competitive level with the most of its competitive set. Between this most recent move by WMT and the relative gap between TGT and the rest of retail, we think that means a much higher investment rate than is currently embedded in street numbers.