Sterne Agee analysts Charles Grom, Renato Basanta and John Parke raise Target Corporation (NYSE:TGT)’s price target and rate the company as a Neutral as the company’s 2014 guidance has holes.
While we’re not surprised to see the relief rally in Target Corporation (NYSE:TGT) shares today (although 7% seems a bit much), we are not convinced that it’s time to step up to the plate and go long. NT, while the guidance bar was reduced, the implied 2Q-4Q improvement in the U.S. segment along with TGT’s overall GPM expectation (+30-40 bps YOY) seems a bit optimistic. LT, structural hurdles (e.g. grocery, merchandise, e-commerce) remain front/center. Net, we’re not chasing it and don’t think you should either. Neutral
Target’s 4Q13 quality = better than expected
Target Corporation (NYSE:TGT) reported adjusted 4Q EPS of $0.90 (including $0.40 Canadian dilution) vs. our in-line with consensus estimate of $0.81 and guidance of $0.75-$0.85. On a consolidated basis, the upside relative to our model came from several line items, including: (a) $0.07 from higher gross profit margins, (b) $0.05 from lower adjusted SG&A, and (c) $0.01 from lower D&A – all partly offset by $0.02 each of a lower-than-modeled tax rate and buybacks. Notably, consolidated sales were in-line as the company hit its down 2.5% SSS target. Regarding margins, retail GPM of 26.9% was down ~80 bps YOY and better than our 26.6% estimate while SG&A (adjusted for $81 million) also came in better at 19.3% vs. our 19.5% estimate. Net, including 5 bps of lower-than-expected D&A, the company’s EBIT margins beat our model by ~60 bps, resulting in ~$0.13 of upside above the EBIT line (~$0.08 US and ~$0.05 Canada; see segment detail below). All told, while comps were in-line, margins were materially better and drove the upside in the quarter against very low expectations.
Gross margins upside the big story
The aforementioned 4Q13 U.S. comp of down 2.5% was in-line with guidance (provided on 1/10/14) and included a 5.5% traffic decline (cycling a down 1.0%), significantly impacted by the 12/19/14 announcement of the data breach. Importantly, 4Q REDcard penetration was up 100 bps sequentially to 20.9% and up 540 bps year-over-year vs. the 590 bps gains the last two quarters – a positive given the potential for a marked slowdown due to the breach. Moving down the U.S. P&L gross margins of 27.6% (SA @ 27.3%) were only down 15 bps, driving the bulk of U.S. upside ($0.07) and surprisingly held up given the (1) poor traffic trends, (2) intensely promotional environment, (3) additional discounting due to the data breach, and (4) additional REDcard penetration. SG&A Expense control was also modestly better at 18.4% (as a percentage of sales; vs. our 18.5% estimate), offset by slightly higher-than-expected D&A. Overall, despite U.S. EBIT $ coming in $76 million better than our estimate, we point out that it was still down 22.4% year-over-year.
Canada segment review
Canada dilution of $0.40 was better than guidance (provided on 1/10/14) of $0.45 and our $0.46 estimate. However, we note that Canadian sales of $623 million were modestly lower than our $631 million estimate and gross margins of 4.3% were below our 5.0% – gross profit actually came in $4.6 million below our model. As such, Canadian upside came entirely from better SG&A/D&A, which combined was $53 million lower than our expectations, potentially reflective of a tighter expense control in light of below plan sales from our friends up North.
Guidance below the street
Target issued new FY14 EPS guidance of $3.85-$4.15 (including Canada), which is below consensus of $4.25 – we had previously estimated FY14 at $3.80 (prior to the 4Q beat) and believe investors were already bracing for EPS in the sub ~$4.00 range given underperforming shares year-to-date. Importantly, we believe that the company’s new guidance incorporates an aggressive target for U.S. gross margins, including a 30-40 bps increase in FY14 – a difficult task, in our view, considering potential price investments and continued REDcard penetration, not to mention very little precedent over the last few years in terms of the magnitude of the guided gains. Furthermore, while 1Q14 EPS guidance of $0.60-$0.75 likely falls short of most models, the company seems to be baking in a meaningful improvement in the U.S. segment from 2Q-4Q, which is concerning. Finally, we also note that while Target Corporation (NYSE:TGT) did not provide an estimate of future expenses related to the credit card data breach, the company chose not to repurchase shares in 4Q13 and won’t again in 1Q14, which is the prudent course to take, in our opinion.
Revising estimates and price target to $56
We revise our estimates to reflect Target Corporation (NYSE:TGT)’s 4Q13 EPS beat and new guidance. Specifically, our FY14 EPS estimate is increased from $3.80 to $3.95 (including 1.2% U.S. comps vs. 0%-2% guidance and ~$0.74 Canadian dilution) and our FY15 EPS estimate is now $4.70, up from $4.50. Our new price target is $56 (up from $54) – predicated on 12x our FY15 EPS of $4.70.