This print was classic Target. Miss, actually puts up a good comp, with 3.7% traffic growth deleveraging to a 3% comp. But still, not bad at face value. But there’s more than just a face. Unfortunately, inventories look terrible, and the company will drive comp in 2Q simply to clear excess inventory at lower GM. E-comm (dilutive) looked good, but the big take away for me is the widening spread in the investment cycle between WMT and TGT (see chart below). We’re seeing SG&A per ft at TGT accelerate to 5.7% vs comps of 3% -- and costs are only headed higher. TGT feeling wage and freight pressure, the former which will only accelerate unless it cuts hours – which hurts service levels and sales.
The reality is that this company simply cannot grow EBIT, and will likely end in an acquisition to do so in order for Cornell to save his job, or at least prolong the firing process. But with precedents like Shipt – basically spending $500mm for something WMT will do for free – TGT’s track record is shoddy at best. Top line compares get very difficult in August – and TGT is refusing to give clarity on its back half guidance beyond “low single digit”. We’re looking for a 2% comp miss with rising SG&A, and a 7% EPS miss for the year. Then a 20% and 25% miss in FY19 and ’20, respectively.
I wish I could call it a $5 earnings annuity, capitalize that by its cost of equity and say that it’s a $50-$60 stock. But I can’t even do that bc the earnings algorithm is so bad over the next three years. The only thing TGT has going for it is that it lacks the multinational exposure of weakening global growth. This is almost as good a short as KSS. Almost. I don’t see why anyone would pay a 4.5% free cash flow yield for a company that can do nothing put up negative EBIT growth and is investing capital at a structurally lower rate than competitors that are 5-10 years ahead in driving consumer connectivity in a #retail5.0 world. Needless to say, I’m short this name and am staying there until we see a big and financially realistic guide-down.
-- McGough
McLean’s Model summary and earnings callouts below.
Revenue
- 3% comp, 60bps slowdown from 4Q, 20bps slowdown on the 2 year.
- Traffic was the topline driver, up 3.7% against an easy compare (slowed 20bps on 2 year basis).
- With traffic so strong it's perhaps odd that comp wasn’t better given management’s bullish commentary on out of stocks at historical lows (with inventory so high, one would hope out of stocks are low). What good are in-stocks if you can’t boost average ticket?
- Ecommerce grew 28% slowing 100bps from last quarter, slowing 650bps on the 2 year.
- There was some help from the 53rd week calendar shift, which management did not quantify. Likely in the 100bps range.
- Looking ahead 2Q should see more benefit from the calendar shift. Hence the guidance for accelerating comp despite the tougher compare.
- 3Q and 4Q get robbed by the calendar, with 4Q being robbed more (according to management).
- Traffic compares getting much tougher the rest of the year, watch out in 2H with the shift and comparison set up.
Gross Margin
- Gross margin down 30bps, with inventory building.
- Management is blaming weather and the impact of not selling as much seasonal product at high margins.
- We think there could be more to it, as WMT is seeing similar gross margin drops while it invests in price and ecommerce.
- Simply put, TGT is getting ‘Wal-Marted and Amazoned’ and refuses to admit it.
- Going forward margins look as bearish with a bad inventory position on continued industry pressure.
- Shipt acquisition scaling up is likely a (small) margin dilution risk.
SG&A
- SG&A grew 5.7%, as TGT invests in wages, people, ecommerce and stores.
- By our math the wage investment from higher minimums is ~2.5-3% in SG&A growth… ~50bps margin.
- Wage pressure and investment will continue in 2018 and 2019 at a minimum – until WMT and AMZN step off the gas.
- The important element on expenses to consider is that the company has many clear cost headwinds and planned investments that are not easy to mitigate or remove.
- That means if the top line isn’t there, there will be significant deleverage on the earnings line. If EPS can miss like we saw in 1Q on a comp beat at up 3%, what happens with a comp miss on weaker growth?
Cash/Other
- Management stated on the call "out of stock position at historic lows"… no kidding, inventory is up the most we have seen since 2013.
- CFFO was down 59% or $745mm… yikes.
Model Changes:
- More bullish on 2Q rev and more bearish on 2H from the calendar shift impact. Net slightly more bullish on revenue for the year.
- More bearish on gross margin given the bad inventory set-up and weak 1Q result.
- Taking tax rate to lower end of guide given 1Q result.
