January 21, 2015 Target Corporation Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Underperform Date of Last Change 12/03/2014 Current Price (01/20/15) $73.67 Target Price $77.00 52-Week High $77.13 52-Week Low $55.07 One-Year Return (%) 27.27 Beta 0.60 Average Daily Volume (sh) 4,531,523 Shares Outstanding (mil) 637 Market Capitalization ($mil) $46,925 Short Interest Ratio (days) 4.05 Institutional Ownership (%) 86 Insider Ownership (%) 1 SUMMARY Risk Level * (TGT-NYSE) After a brief stint, Target has decided to shut down its Canadian operations as the company struggled to attain profitability in the region. With respect to this the company is expected to record a pre-tax loss of $5.4 billion in fourth-quarter fiscal 2014. Nevertheless, the company believes that the closure will be accretive to its earnings going forward as it will enable to deploy resources solely in the domestic markets and in developing its omnichannel capacities. Performance in the U.S. has already started to improve given the company s overhauling drive, effective price and inventory management along with product diversification. These led the company to post better-than-expected third quarter results. Despite the beat, the company has maintained a cautious commentary for the fiscal as consumer spending remains volatile. Moreover, it narrowed its fiscal 2014 earnings guidance range. Currently, we stay Neutral on the stock. Below Avg., Type of Stock Large-Blend Industry Retail-Discount Zacks Industry Rank * 36 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Apr) (Jul) (Oct) (Jan) (Jan) Annual Cash Dividend $2.08 Dividend Yield (%) 2.82 5-Yr. Historical Growth Rates Sales (%) 2.9 Earnings Per Share (%) 2.7 Dividend (%) 23.9 using TTM EPS 25.2 using 2014 Estimate 20.1 using 2015Estimate 17.7 2012 16,537 A 16,451 A 16,601 A 22,370 A 71,960 A 2013 16,706 A 17,117 A 17,258 A 21,516 A 72,596 A 2014 17,050 A 17,406 A 17,732 A 21,840 E 73,355 E 2015 17,192 E 17,453 E 17,782 E 17,782 E 74,928 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Apr) (Jul) (Oct) (Jan) (Jan) 2012 $1.03 A $1.03 A $0.77 A $1.47 A $4.28 A 2013 $0.82 A $0.98 A $0.56 A $0.90 A $3.25 A 2014 $0.70 A $0.78 A $0.54 A $1.46 E $3.66 E 2015 $0.98 E $1.11 E $0.81 E $1.27 E $4.17 E Projected EPS Growth - Next 5 Years % 9 Zacks Rank *: Short Term 1 3 months outlook 2 - Buy Revenue figures exclude U.S. Credit Card Segment Revenue, Earnings related to U.S. and Canadian operations. Annual figures may not add up to rounding * 2015 Definition Zacks / Disclosure Investment on Research, last page All Rights reserved. off. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Founded in 1902, and headquartered in Minneapolis, MN, Target Corporation (TGT), operates through two reportable segments: U.S. and Canadian. U.S. Segment consists of retail operations across the entire United States. The U.S. Segment also includes the company s credit card servicing activities and certain centralized operating and corporate activities. Canadian Segment consists of Canadian retail operations. The company ventured into the Canadian market in 2013. Target does not have a digital sales channel for Canadian customers. In the first quarter of 2013, Target completed the sale of its credit card portfolio to TD Bank Group at gross value of $5.7 billion. As of Jan 15, 2015, Target operated 1,801 stores in the United States, of which 249 were general merchandise stores, 1,294 were expanded grocery assortments, 249 were SuperTarget stores and 8 CityTarget stores with 1 TargetExpress store. The company also operated 133 stores in Canada on the same date. On Jan 15, 2015, Target announced to discontinue operations in Canada. The company will now report results for its U.S operation and mark Canada as discontinued operations beginning with company s fourth quarter of fiscal 2014 results. REASONS TO BUY Winding Up from Canada to Focus on Domestic Market: After a careful evaluation of Canadian operations, Target concluded that attaining profitability in the region was not possible before 2021, which compelled the company to abandon Canada and focus on its domestic business. Target estimates the cash cost of winding up to be somewhere around $500 to $600 million, to be accounted for in fiscal 2015 and beyond. Further, the company expects to record $5.4 billion in pre-tax losses from the discontinuation of the operations in the fourth quarter of fiscal 2014 and another $275 million in fiscal 2015. Target has stated that it has enough resources to meet these expenses. We believe that moving out of Canada would be beneficial to Target as it can now focus on its domestic market and omnichannel capacities. Target s performance in the U.S. has shown signs of progress. In the U.S. comps have been positive in the recently concluded quarter. Overhauling of operations, effective price and inventory management along with diversification of assortment has helped to lift the financial performance. Moreover, it is can now focus specially on developing online portal in order to keep in sync with changing trends and also to boost revenues. Furthermore, the company is adding more products to its online assortment and providing free shipping. Additionally, with Brian Cornell being elected as the Chief Executive Officer and Chairman, management is hopeful of battling nearterm headwinds and transforming into a leading omni-channel retailer. The effects of the data breach are also wearing off much to the relief of the management. CityTarget & Target Express Stores: Target continues to lay emphasis on developing smaller format stores to penetrate deeper in urban areas. Earlier, Target used to concentrate on large format stores for a particular location, which lowered its accessibility to the country s densely populated urban regions and space-crunched cities. However, with the changing business scenario and rising competition, Target felt the need to have stores of various sizes and formats to align with the targeted area. We believe that this approach will help the company to augment its sales. As a part of the Equity Research TGT Page 2
strategy, Target which opened its first TargetExpress store in Minneapolis earlier this year, announced its plans to expand the smaller-store format (15% of the general merchandise store) into the state of California by opening two TargetExpress outlets. Earlier, Target, similar to that of its biggest rival Wal-Mart Stores, had introduced CityTarget, a smaller-store format of 60,000 100,000 square feet compared with the current format of 125,000 180,000 square feet, again to tap the urban markets. As of now, Target operates 8 CityTarget stores. $1 Billion in Cost Cutting: Target has adopted an aggressive cost reduction strategy. The company plans to reduce $1 billion in annualized costs by 2015, out of which $200 million have already been achieved in 2013. For 2014, Target expects another $650 million in savings taking the total to $850 million. The savings is expected to improve margins, going forward. Catalysts Driving Growth: Target s efficient marketing approach, multi-channel strategy, product innovation, compelling pricing strategy and new merchandise assortments should help drive comps and operating margins in the long term. We expect the company to gain market share and believe that more focus on consumable items should boost sales and earnings in a sluggish consumer environment. REASONS TO SELL Stiff Competition Straining Margins: In the retail segment, Target faces stiff competition from discount stores, department stores, drug stores, specialty stores, supermarkets, wholesale clubs, and other forms of retail commerce, contingent on location, price and quality of merchandise, in-stock consistency, merchandise assortments, and customer service. We believe that unhealthy price competition to gain market share and attract footfall might weigh on the company s results. Geographically Less Diversified: Winding up from Canada leaves Target s presence restricted to only U.S market. We believe this poses a competitive threat to Target, compared with Wal-Mart and Costco, which are geographically diversified and more resourceful. In our view, diversification strategy is a natural hedge against risks that may arise in specific markets. Cautious Outlook: Earlier, the company, despite an earnings beat, had maintained a cautious outlook for the fiscal 2014 as consumer spending continued to be volatile. Moreover, the charges related to data breach would be incorporated in the fiscal results. The company during the third quarter fiscal 2014 conference had forecasted earnings per share to be in the range of $3.15 and $3.25 for fiscal 2014 as against earlier projected range of $3.10 to $3.30 per share. Now, it expects the discontinuation of Canadian operations to result in $5.4 billion in pre tax losses in the fourth quarter of fiscal 2014. All these developments are likely to prove a drag on the quarterly performance. RECENT NEWS Target to Close Canadian Operations with $5.4B in Losses Jan 15, 2015 Target has decided to wind up its unprofitable Canadian operations less than 24 months after its foray in the country. After a comprehensive evaluation of the business, it was concluded that attaining profitability in the region was not possible before 2021, which compelled Target to abandon Canada and focus on its domestic business. Equity Research TGT Page 3
Target estimates the cash cost of winding up to be somewhere around $500 to $600 million, to be accounted for in fiscal 2015 and beyond. Further, the company expects to record $5.4 billion in pre-tax losses from the discontinuation of the operations in the fourth quarter of fiscal 2014 and another $275 million in fiscal 2015. As per sources, Target has spent over $4 billon on its Canadian business. It opened the first three pilot Target stores in Canada in Mar 2013. Target expects the closure of Canadian operations to be accretive to its earnings and cash flow going ahead. The company will be shuttering all 133 stores resulting in 17,600 people losing their jobs. However, the company will provide all the employees a minimum of 16 weeks compensation through a $59 million Employee Trust Fund set up under the Ontario Superior Court of Justice s scrutiny. Analysts observe that Target has been trying to improve its Canadian business since its inception but a series of problems, such as supply chain issues and stiff competition from local retailers, dragged its performance down. The company could not improve its supply chain and that left its store shelves poorly stocked, leaving customers agitated. Moreover, the company was apparently offering goods at a higher price compared with its U.S. stores. This did not go down well with the Canadian customers. An average Canadian shopper is highly value for money -oriented and even does cross-border shopping. Though the company tried to improve the pricing mechanism, it could not gain a solid ground. This is because of a competitive Canadian retail landscape where local retailers dominate along with some of the American counterparts like Wal-Mart. Wal-Mart came to Canada in 1994 and since has long established its operations in the country. Analysts concluded that Target failed because the company was doing too many things in too little time. A step by step approach along with better understanding of the Canadian customer base would likely have burnished healthier results. Nevertheless, Target s failure is a lesson to other retailers like that have recently begun expanding into the Canadian territory. Target Q3 Earnings Surpass Estimates on Upbeat U.S. Sales Nov 19, 2014 Target posted third-quarter fiscal 2014 results, wherein adjusted earnings of $0.54 per share surpassed the Zacks Consensus Estimate of $0.47 on the back of better-than-expected U.S. sales and improved performance on the Canadian turf. This gives a positive signal just before the busiest season of the year. It seems that Target is gradually emerging from the massive data breach that hit it in the last holiday season. Target has been trying hard to improve traffic count at its domestic stores and strengthen its position in Canada with sound marketing and merchandising initiatives. Additionally, with Brian Cornell being elected as the Chief Executive Officer and Chairman, management is hopeful of battling near-term headwinds and transforming Target into a leading omni-channel retailer. However, earnings per share did decline 2.9% year-over-year due to increase in cost of sales and higher depreciation and amortization. Equity Research TGT Page 4
Let s Unveil the Picture Total sales increased 2.8% to $17,732 million from the prior-year quarter and came ahead of the Zacks Consensus Estimate of $17,529 million. Sales for the U.S. segment came in at $17,254 million, up 1.9% year over year. Minneapolis-based Target s comparable-store sales for the quarter increased 1.2% against 0.9% growth registered in the prior-year quarter. The number of transactions edged down 0.4%, though the average transaction amount climbed 1.6%. Gross profit at the U.S. segment inched up 0.2% to $5,083 million, while gross margin contracted 50 basis points to 29.5% due to higher promotions. Segment operating income fell 5.2% to $927 million, whereas operating margin contracted 40 basis points to 5.4%. Target s credit card penetration increased 30 basis points to 9.8%, whereas debit card penetration expanded 80 basis points to 11.2% during the quarter. Total REDcard penetration climbed to 21% from 19.9% in the year-ago quarter. We believe Target s P-fresh remodel program, 5% REDcard Rewards program and Price Match strategy will help in augmenting sales. Sales generated from the Canadian market during the quarter were $479 million, up substantially from $333 million in the prior-year period. Comparable-store sales jumped 1.6% in the quarter. Gross profit at the Canadian segment soared 89.6% to $93 million, whereas gross margin expanded to 19.5% from 14.8% due to clearance of inventory. Target s credit and debit cards penetration in Canada came in at 1.9% and 2.3%, up 50 basis points and 80 basis points, respectively. Total REDcard penetration came in at 4.2% compared with 2.9% in the prior-year period. Other Financial Details During the quarter, Target did not repurchase any shares but paid dividends of $330 million, up 21.4% year over year. The company ended the quarter with cash and cash equivalents of $780 million, longterm debt and other borrowings of $13,809 million and shareholders equity of $16,373 million. Peek into Guidance Target now projects adjusted earnings in the range of $1.13 to $1.23 per share for the fourth quarter and between $3.15 and $3.25 per share for fiscal 2014. Earlier, the company had projected earnings in the band of $3.10 to $3.30 per share for the full year. Target s Strategic Initiatives Management indicated that Target s P-fresh remodel program, Expect More and Pay Less brand promise Pharmacy rewards program and 5% REDcard Rewards program will help sustain sales momentum, continue to drive traffic and enhance customer shopping experience. The company in order Equity Research TGT Page 5
to attract customers is also providing an additional benefit of free shipping for any e-shopping, to its cardholders, who are already getting 5% off on their transactions. Target plans to sustain its remodeling program at existing general merchandise locations by adding perishable food items, along with a deeper assortment of dry dairy and frozen items, and improved store layout and enhancement of in-store shopping experience across departments, such as apparel, home, beauty, shoes, and baby. Target plans to increase its investment in technology and supply chain to improve its multi-channel capabilities, including digital channel. Target, in order to augment its presence in key markets, has been attempting to acquire small businesses and DermStore Beauty Group, an online beauty retailer is the latest addition. The company is also gradually extending its Beauty Concierge program. Earlier, in March 2013, Target had entered into 2 separate transactions to acquire CHEFS Catalog and assets of Cooking.com to tap the rapidly expanding cooking and kitchenware market. Another opportunity, which Target wants to explore, is the expansion of its stores into the international markets, such as Canada and Latin America. Target, in order to expand its global footprint, has been eyeing the Canadian market for a long time, and has accomplished its goal of opening 124 stores in 2013. The stores will carry items ranging from beauty and apparel to home, grocery, and personal care. Moreover, Target announced its year-round price matching policy with the aim of offering its patrons the facility to match the prices being offered by online retail giants such as Amazon.com Inc. s Amazon.com, Wal-Mart s Walmart.com, Best Buy Co. Inc. s BestBuy.com, and Toysrus.com. The company remains on track to attain earnings of $8.00 per share or more by 2017. The company also expects to achieve 3% annual growth in comparable-store sales on an average (as announced earlier). Dividend Update On Jan 15, 2015, Target announced its regular dividend of $0.52 per share, payable on Mar 10, 2015 to stockholders of record as on Feb 18. This marks the 190th successive dividend payment for the company ever since it went public in Oct 1967. The company last raised its annual dividend by 20.9% to $2.08 per share earlier in June 2014. Equity Research TGT Page 6
VALUATION Target s current trailing 12-month earnings multiple is 25.2X compared with 39.3X, the industry average and 18.6X for the S&P 500. Over the last five years, Target s shares have traded in a range of 11.4X to 22.9X trailing 12-month earnings. The stock is also trading at a discount to its industry average, based on forward earnings estimates. Our target price of $77.00, 18.5X 2015 EPS, reflects this. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Target Corp. (TGT) 20.1 17.7 9.0 9.4 25.2 22.9 11.4 Industry Average 25.2 21.4 13.6 25.0 39.3 187.4 14.8 S&P 500 16.1 15.1 10.7 15.9 18.6 19.4 12.0 Costco Wholesale Corporation (COST) 27.0 24.6 11.4 19.8 29.0 29.5 19.2 Sears Holdings Corporation (SHLD) N/A N/A N/A 113.7 N/A N/M 20.1 Wal-Mart de Mexico SAB De CV (WMMVY) 18.4 17.1 8.3 15.4 21.6 34.8 19.2 TTM is trailing 12 months; F1 is 2014 and F2 is 2015, CF is operating cash flow P/B Last Qtr. P/B P/B ROE D/E Div Yield 5-Yr High 5-Yr Low Last Qtr. Last Qtr. Target Corp. (TGT) 2.9 2.9 2.1 13.0 0.8 2.7 9.4 EV/EBITDA Industry Average 6.2 6.2 6.2 8.4 1.2 0.7 49.0 S&P 500 5.1 9.8 3.2 24.8 N/A 2.0 N/A Equity Research TGT Page 7
Earnings Surprise and Estimate Revision History Equity Research TGT Page 8
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of TGT. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1114 companies covered: Outperform - 15.6%, Neutral - 77.9%, Underperform 5.9%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research TGT Page 9