There’s a lot of reasons why we don’t like Target. It’s not because of any one factor – as most of those, at least in isolation, are known. But what is underappreciated – in a very big way - is the cumulative effect of a decade of mediocre/reckless decision making that has left the company in a difficult position, and one without the leverage to drive the business, the P&L and cash flow forward without eroding returns. We think this is probably in numbers for the back half of this year. But this company will have to back off of guidance and expectations, and ultimately take necessary steps (higher investment) to maintain competitive position, else see continued top line pressure and earnings misses. Here’s how the timeline adds up from our perspective…
1) By 2008 the company started to feel pressure in a more meaningful way from all angles. Wal-Mart on one side, the department stores on another, then supermarkets, dollar stores, and home furnishings retailers. The kicker was the impact of Amazon’s pressure from above starting to materially impact the competitive set.
2) But this pressure was then masked by the Great Recession. Though this was very real, it arguably made TGT (and most others) fail to invest, stemming the underlying share loss, as management chalked up virtually all of the weakness to the economy. We disagree with this.
3) In 2010/11, after accelerating the Red Card and converting 64% of the chain into the supermarket business, Steinhafel had no other alternative than to go into Canada. For the record, Canada is rarely ROIC-accretive for any retailer. Also for the record, we’re not against the supermarket business for TGT, as it simply puts pressure on the incumbents. But the ‘Tar-Jay’ allure of picking up a Mossimo sweater, a private label scarf or something with a Swoosh on it is somewhat compromised by turning the box into a source for fruit, milk and frozen peas.
4) Then we had the data breach, leading to higher costs, lower near-term revenue, and Steinhafel ultimately getting fired. Some argue that he could not have foreseen this. We think it’s the CEOs responsibility, implied by his compensation, to put the risk management in place to avert such disasters. But that’s arguably water under the bridge at this point.
5) Fast forward to 2014 and the hire of Brian Cornell.
- Made the tough decisions, but basically was reversing the bad calls from his predecessor.
- Got out of Canada.
- Sold the Rx business to CVS.
- Fired 1.5k home office employees and took down want ads for another 1.5k more.
- Let’s not forget that he benefitted from a ‘data breach’ sales recovery for 1.5 years.
- We think Cornell’s largest mistake was that he had a free pass to take down expectations for 3-4 years, and invest in the business accordingly. This is what WMT’s (new) CEO Doug McMillon did – and that was, by a country mile, the right call.
6) Today, the strategic plan for Wal-Mart vs Target vs Amazon is in the spotlight.
- AMZN is capturing a full 25% of incremental consumer dollars – a simply staggering number. This is closer to 40% of total online spending.
- On the other side you’ve got Wal-Mart, which…
- Planned four years of investment in people, price, and e-commerce.
- Just bought jet.com – on top of several smaller acquisitions – to build and drive its e-commerce business. In fairness, this has yet to accrue to WMT’s results. But the underlying investment is there.
- Target has a 5-year $2bn cost saving program, which is fine. But we’d rather see SG&A go up as opposed to down. Target’s 5-10 year plan does not seem to include meaningful contribution in the core US market.
- The recent numbers are clear. We’ve seen 9% growth in SG&A per square foot for WMT over the past two years. It’s been negative for Target (and yes, this is even normalized for the CVS deal).
7) Target’s comp plan is for 3% – something it should never have guided to – with the plan to manifest itself into low double digit EPS growth (i.e. margin improvement and balance sheet leverage – debt reduction and share repo).
- We think the top line will miss in 2017 due to weaker investment today.
- E-commerce is simply weak – full stop – despite all the discussion of how big of a growth opportunity it is. Newsflash: it is an opportunity for EVERYONE, and competitors are investing ahead of it. Today e-comm is only 3% of sales for Target. In 2015 it grew at 30%, but growth slowed to 16% in the quarter the company just reported.
- WMT is no better today. But it is investing. Moreover, the performance gap in e-comm is narrowing meaningfully between the two – with WMT taking share.
- WMT invested $3bn to acquire the people and technology to augment what they unsuccessfully tried to build for 10 years.
8) Recognized $1.9 billion from the CVS deal, and mis-spent it by buying back in the high-$70s/low $80s. Note, the stock is now 16% lower – a large delta for a company with a perceived risk profile as low as TGT.
9) Cash flow remains solid, in fairness, though we simply think it is being poorly redeployed – past the peak shareholder return.
10) On both TRADE/TREND durations, we’ve got comps at the bottom of the barrel for the next two quarters. That’s why the multiple is where it is (13.2x consensus earnings). But that’s also why we’ve had more inbound calls on TGT over the past month than we’ve seen in nearly a year.
- But from here, with the absence of major levers to pull like exiting Canada or selling Rx, we think that there’s no reason why the company will not post an eroding profit algorithm, which will start with missed growth targets. Either that, or…
- Cornell owns up and announces a major investment plan aside from keeping up with WMT on wages or investing in transgender bathrooms.
Simply put, historically Target has been largely a macro call, as is Wal-Mart. But we increasingly think it’s clear that this is no longer the case. We think what’s missing in investors’ minds on this one is the duration that this sub-par performance will rear its true form. Our estimates are 15% below consensus next year, and 30% by 2019.
One thing we balance with all of this, is that the biggest thing this name has in its favor is that after all, it is Target. Will it be here in 10 years? Yes, it will. Will Kohl’s? Probably not. Bed Bath & Beyond? Not sure. Best Buy? Probably not. Ultimately this company will probably survive without egregious mismanagement. But we don’t like companies that simply survive – especially without respecting the precarious position they’re in today. And Target is definitely in one from where we sit. The company will likely ultimately do the right thing, we just think it will be costly before it ensures survival.
