Here’s a major theme with both TGT and KSS
In jousting terms, both companies are ‘withdrawing from the approaching lance when they should lean in’. That’s how you ultimately lose the tournament (and get fired – at the company, and on Wall Street).
If you are the kind of investor who likes (and is allowed) to short when the market is (unknowingly) rewarding a company for putting up an extra $1 eps today at the expense of $3 tomorrow, look no further than TGT and KSS (and HBI – our three top shorts). I’m wrong today on TGT. Was wrong on Thursday on KSS.
But the research call has not changed. In fact, it is stronger, based on both companies pulling capital out of their models to a greater degree while they obfuscate the declining credit impact on the P&L (the word ‘credit’ was not mentioned by management on either the TGT or KSS calls).
Wrong is wrong. Pain today. But this ends bad.
A Good ‘Bad Number’ From TGT. We backed off of pressing this one into the number, but are wrong today regardless. Stepping back, this management team is on the ropes. Can’t decimate SG&A and expect to accelerate growth. It is KSS all over again.
The $1.04 in earnings was good for a 25% earnings beat and 23% growth YY. While we said not to press the short into this print, the fact is that in no way did we expect TGT to beat by this magnitude. In other words, I am wrong today.
But this is like KSS all over again.
- Comps were about in-line with our model, as were Gross Margins. BUT….
- Sales growth down 7%, or -0.7% ex the pharmacy sale. That’s composed of a 0.7% sq. ft. decline, and a -0.2% comp. The number we are focused in on is the -1.2% decline in traffic. Up 100bps sequentially from -2.2 in 2Q16, but just a 40bps improvement in the 2yr run rate. That’s not sustainable.
- TGT managed to leverage -6.7% sales growth, and a negative comp, into +23.2% earnings growth (huh?).
- Gross margin expanded 80bps. 70bps better than expectations, but if we strip out the pharmacy benefit, gross margins were flat YY in the core business. Certainley better than anticipated gross margin performance, and inventories corrected slightly, but we think the levers on this line are going to be hard to squeeze with no solution in place to fix the traffic declines. Gross profit shrunk by 3.9%
- SG&A was down 7.1%. Excluding the pharmacy benefit to the SG&A line, YY dollar growth was down 4.1%. That’s the lowest rate of SG&A growth the company has reported since 2010. More importantly SG&A per square foot was down 1.8%. That compares to 0.7% in 1Q16 and 2Q16, which was already dangerously low. Especially in light of the fact that WMT SG&A/sq. ft. is tracking at 9% growth and the other biggest rival AMZN is spending through the nose and taking 28% share of the incremental consumers dollars.
- Traffic was down by 1.2%, with no improvement in 4Q to date.
- E-comm improved to 26% growth (180bp acceleration on a 2-year) – which is a positive. But even with this boost, the company still did not comp.
- EBIT grew by 10% -- entirely due to SG&A decline.
- Non-operating items including share buybacks and a slightly lower tax rate attributed 1200bps+ to the growth rate this quarter. While the $875mm in buybacks this quarter at an average price in the high $60s isn’t as aggregious as the $2bn the company spent earlier this year in the mid-$70s, but we think the capital deployment objectives of this team are mis-aligned to generate positive returns.
- On the share count – it’s worth noting that even with the pre-market rally – the stock won’t touch the $80 level where TGT bought back stock earlier this year.
- To characterize management’s tone on this call, the best word to use is ‘bubbly’.
- This is a management team that very complacent putting up sub-par core growth, and lacking the foresight to invest against a strengthening competitive base.
- Not a single member of the team had a command over what is in place to turn the negative traffic trend around.
- The strongest statement I heard so far is that [this will work] because ‘We Have The Best Team in Retail.” (It sounds like Kohl’s ‘Greatness Agenda’).
- To me, this sounds like a CEO who is fighting for his job – whether he knows it or not.
- Again, I am wrong today by underestimating how much SG&A TGT could cut out of this model. But is that what we REALLY want to see when WMT and AMZN are both going the other way.
- I’ve heard nothing so far that makes me take UP our 2017, 2018 And 2019 numbers which were 11%, 18% and 27% below consensus as of yesterday – and will likely be further below after today.
The big highlight in all of that is the clear unwillingness of this management team to invest in the business, evidenced by the 1.8% decline in SG&A/sq.ft. when normalizing for the pharmacy transaction. It’s no wonder that the traffic issue hasn’t been resolved. It’s one thing for KSS to underspend now in order to harvest cash flow given that the business model is stuck between a rock and hard place. While we think it’s a great shorting opportunity as the management team waves the ‘white flag’, we also commiserate with the fact that it’s a business that likely won’t be here in 10yrs. No matter the strategic actions, or management in place to steer the ship.
TGT is a different animal altogether. Will it be here in 10 years? Yes, it will. 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.
Additional Details from Richards at 32,000 Feet en Route to RH in Seattle…
Investment Trends Headed The Wrong Direction
TGT has talked up its investment plan, which calls for $2bn in cost savings to be stripped out of the P&L to be reinvested in the business. As of this quarter the company hit that stated goal. There has never been a high level of transparency when it comes to the buckets where there is room to pare back spending, but given the commentary today on the call it appears that TGT will again go back to the well in order to chop more from the cost structure. In dollars, what we can see is that the SG&A/sq. ft. growth rate hit -1.8% this quarter. The lowest rate in Cornell’s tenure – that’s an alarming rate on its own, but in the broader context of what’s happening across the industry, we don’t see how Target wins sticking with this M.O. Target already has the least enviable competitive set in retail, stuck between WMT, AMZN, dollar stores, grocery stores, and department stores.
And it’s competitive set has already sacrificed near term-earnings in favor of playing the long-game. That’s clear as day when you consider the strategic actions at WMT where SG&A/sq.ft. is up 9% and the company just spent $3.3bn to supplement its underdeveloped and underfunded e-commerce business. Amazon isn’t making it any easier on the market share side taking 28% of the incremental consumers dollars as of this past quarter. So as these other companies continue to do the right things in order to generate traffic, volume, and ultimately market share we think TGT continues to lose.
One Of The Positives
We’ve been critical of TGT’s inability to grow it’s e-commerce business at a rate consistent with the industry. At 26% growth this quarter, it’s good for a 1000bps improvement sequentially. Though we would point out that despite the sequential improvement it wasn’t enough to generate positive comps (or traffic), meaning the e-commerce growth rate came at the expense of the brick and mortar business which comped down 1%, the 2nd lowest growth rate reported since the company started disclosing e-commerce sales. Some of that can be attributed to TGT’s decision to run a 10% off the entire basket promotion during the quarter. Cornell rightly pointed out that 26% growth was about 2x the industry average, we’d argue that it should be 4x given the low penetration of the channel at 3.5% relative to the rest of retail. There is a lot of capital that needs to be invested in this arena for TGT to win.
Let’s End On Traffic
We’ve seen a sizable gap open up in the traffic rates between TGT and WMT. We think that’s no surprise given the amount of capital that’s been redeployed into the business from each of the parties involved. We won’t know the WMT traffic count until tomorrow morning, but we expect to see a continuation of the trend. That’s so bearish for TGT who is grasping at straws to figure out what has caused the meaningful underperformance – especially since it came just months after guiding to 3% annual comps
