THE HEDGEYE EDGE
Target (TGT) is the posterchild stock that loses in what we call #Retail5.0, the next evolution in US retail. Ecommerce is the disintermediator to convenient local shopping locations. Online shopping is convenient for the consumer, but more costly for the majority of retailers. That negative tail outlook, in the context of a bearish trend set-up for the company and bearish US macro makes TGT a solid short idea over a trend duration at these stock prices.
Ultimately we see weakening sales and profit growth for TGT in 2019, and earnings downside vs street expectations of 15%-25%.
INTERMEDIATE TERM (TREND)
TGT has reported its holiday results including a 5.7% comp. It left its EPS at a wide range for the year, perhaps implying the profit flow through could be worse than expected when 4Q is wrapped up and reported.
Toys were likely a comp benefit as many retailers stocked up in hopes of share capture opened up from the Toys R Us bankruptcy and closure. This creates a near-term sales help, but it’s a risk beyond the holidays as there will likely be toys that didn’t sell, and increasing penetration in Toys is not a long-term winning move (hence why Toys R Us is gone).
We see gross margins being pressured in this business for the foreseeable future. In Q4 the company got aggressive with free shipping offering 2-day shipping on hundreds of thousands of items. Amazon lowered free shipping thresholds for the holidays, and it noted this being a drag on gross margins (which missed in 4Q). It's likely TGT’s comps were buoyed by the shipping offer, but margins were likely pressured.
Margins will continue to be pressured by the secular channel shift to lower margin ecommerce sales. Lastly, TGT sits with one of its highest inventory positions we have seen relative to sales, which we think means margin pressure from clearance on the horizon.
With that gross margin pressure, the street is modeling GM% flat in 2019, we think that is overly aggressive.
SG&A has been growing rapidly for TGT as store investments and minimum wage increases push up operating expenses. The street is expecting 3% growth in 2019, we think the step up in minimum wage is about 2pts of growth pressure, meaning underlying growth of 1. That’s fine if comps are +/- 1%. But the street is looking for ~3% comps, that would likely come with total SG&A growth of 4-6%.
Along with the release of the Holiday results the company noted that its CFO would be retiring. Generally a departure of an exec like this is not a positive. It could be due to poor performance or a poor outlook on the business, which is negative for near term results. It could also just be a personal decision which beyond the transition time of filling the role is not a major event. Either way the management change up is at least a slight negative in our view.
The last and perhaps most important part of the trend set-up for TGT is the fact that the US economy sits in #Quad4 (both real growth and inflation are slowing), and is heading into #Quad3 (characterized by real growth slowing while inflation is accelerating) in 2Q. The 2nd worst quadrant for multiline mass retailers like TGT is Quad4, and the worst is Quad3.
LONG TERM (TAIL)
Looking over the long term for TGT, several secular changes apply pressure to the long term earnings of the company.
Ecommerce channel shift will persist and pressure gross margins for the years to come. The effect of #Retail5.0 on brick and mortar productivity will continue as well. Those mean significant pressure on margins and returns for a company like TGT with a massive store base and growing ecommerce businesses.
The company has SG&A pressure from its minimum wage change through 2020, when it will hit a $15 minimum. Again, about 2pts of SG&A growth a year.
Lastly the competitive intensity remains high with WMT and TGT vying to win both in store and online. TGT is the least invested for the changes happening and sits in 3rd place in the race to be the US retailer of the future. TGT won’t go down without a fight, but that means continued investment and pressure on earnings which will drive this stock lower.
ONE-YEAR TRAILING CHART
