Target Corp. And The Tale Of Discount Retailers

Is retail in a ‘terminal recession’? Not according to Ross and TJ Maxx — both apparel retailers are still posting single digit comps despite the notable threat from Amazon. Their shareholders haven’t done too shabby:

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5-Year Chart of Ross Stores, Inc., S&P 500, and T.J. Maxx. (Source: Yahoo Finance)

I’ve been an Amazon Prime member for about five years. I signed up because I could purchase goods online at lower prices and have them shipped to me at no cost (free 2-day shipping) — it was a no brainer. While most people contend online shopping to convenience, convenience has its price and at the end of the day, consumers are price conscious. Ross and TJ Maxx offer unsold apparel from the big box department stores at depressed prices which makes them attractive even in the face of Amazon. A pair of Levi Jeans that one might purchases at Macy’s for $60 sells at Ross for $20. Ross hasn’t even put much of any effort into online shopping — a visit to the website refers you to a physical store and yet, the retailer posted 7% increase in comparable sales last quarter. So is retail dead? Depends on who you ask. Discount retailers that sell commoditized products are more likely to survive, or better yet, die at a slower pace than their specialty counterparts so I do not think they should be written off.

I do agree that stagnation is likely going forward for Target but the stock traded at a decent valuation relative to the general market and that made it attractive to me. What happened post earnings was less about Amazon and more about the guidance and management’s strategy — price cuts to drive foot traffic (lower comps, less income) and $7 Billion CapEx program. Why management would reinvest 20% of their market cap into a terminal business mystifies me. Investors are already skeptical of retail’s ability to compete with Amazon, and so I believe the reaction was warranted.

I was satisfied with receiving a forward 8% earnings yield, 4% dividend yield, and at 1% terminal decay rate. My assumption was that the bad news was priced in, but I did not expect mgmt to pull tricks out of the hat. Management’s decision to reinvest into a terminal business leaves me uneasy. I’m not sure if mgmt actually believes spending $7 Billion will make a difference or if it is just a way to save face and prolong the inevitable. I sold my position at a total loss of 8.7% on earnings day because the stock became too pricey for me based on the new revelations. It sucks, but it is a lesson learned. I am willing to buy some shares in the low 40s if it gets there.

 

Walmart

Walmart reported earnings last month with revenues and comparable store sales rising 3% and 1.8% (currency adjusted), respectively. The results were driven by a 1.4% increase in traffic. The operating side wasn’t exactly stellar but it was better than what markets expected and hence the price appreciation and Markets to a certain extent had priced in a bad quarter. My goal was to ride the post-earnings momentum wave to $75 and then sell but the Target mayhem ruined the possibility of that. I’m likely going to trim or sell off my position in the near future.

Target $TGT and Walmart $WMT

Real Time price Walmart: WMT 74,84 -0,70 -0,93%

Real Time price Target: TGT 50,76 +0,13 +0,26%

I added Target ($63.55) and Walmart ($66.56) to the portfolio today at 16.66% each. The portfolio now holds approximately 33% cash. Target revised its FY16 guidance earlier in January which sent the stock off 12% YTD. The weak retail environment and Target’s soft guidance sent Walmart off its December highs, down about 8%. Markets seem to be pricing in a weaker than expected quarter for Walmart. In an expensive market where Target trades at half the value of the market and Walmart trades at around 60% of the market, Target offers an 8% forward earnings yield and Walmart offers 7%. They both look like great deals, IMO. Although I do agree that Amazon is indeed taking over the world, the pace at which that happens does not warrant their valuations, especially given that these companies are known for earnings stability. One other headwind facing not just retail companies, but virtually all U.S. domiciled companies or anyone that imports goods is the surging U.S. Dollar.

Another positive to these companies is that both Target and Walmart own the vast majority of their stores. I remember reading about Bill Ackman’s activist circa 2008 campaign to get Target to spin off its real estate to ‘create value.’ Given the obvious threat Amazon poses today, an activist that attempts the same coup will likely be backed by more shareholders. I have no idea what their real estate is worth, but it is likely a significant portion of their market caps.

Disclosure: Long TGT and WMT