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Target Beats, Ups Outlook

Zacks Equity Research

Amidst sluggish economic environment, cautious consumer spending and intense competition, Target Corporation (TGT), the operator of general merchandise and food discount stores in the United States, posted better-than-expected second-quarter 2012 results on the back of healthy sales. Lower shares outstanding also provided cushion to the bottom line.

The company delivered quarterly earnings of $1.06 per share, which rose 3.4% from $1.03 earned in the prior-year quarter and also came ahead of the Zacks Consensus Estimate of $1.01.

However, excluding costs related to Canadian operations, earnings from its U.S. operations came in at $1.12 per share, up 4.6% from $1.07 posted in the year-ago quarter. The quarterly earnings dovetails with the company’s previous projection of $1.04 to $1.14 per share.

The healthy results prompted management to raise its fiscal 2012 earnings expectations.

Let’s Unveil the Picture

Total revenue climbed 3.3% to $16,779 million from the prior-year quarter, and beat the Zacks Consensus Estimate of $16,769 million. Retail sales grew 3.5% to $16,451 million as shoppers are gradually opening their wallets but remain wary.

Minneapolis, Minnesota-based Target said that comparable-store sales for the quarter rose 3.1% compared with 3.9% increase registered in the prior-year quarter. The number of transactions rose 0.7%, whereas the average transaction amount climbed 2.4% in the quarter.          

Gross profit at the Retail segment jumped 2.6% to $5,154 million; however, gross margin shrank 30 basis points to 31.3%, as the rate of increase in sales were not able to fully offset 3.9% rise in cost of sales. Segment operating income increased 2.9% to $1,181 million, whereas operating margin remained flat at 7.2%.

The company indicated that revenue from the Credit Card segment tumbled 5.1% to $328 million. Target also said that segment profit dropped to $140 million in the quarter from $171 million in the prior-year period.

Target’s credit card penetration increased 110 basis points to 7.7%, whereas debit card penetration expanded 300 basis points to 5.1% during the quarter. Total store REDcard penetration climbed to 12.8% from 8.7% in the year-ago quarter.

Target’s P-fresh remodel program, 5% REDcard Rewards program and The Shops at Target will help sustain sales momentum, continue to drive traffic and enhanced customer shopping experience. The company’s focus on “Expect More. Pay Less.” brand promise is also bearing fruits.

Further, Target, in order to tap the urban markets where real estate remains a constraint, plans to introduce smaller-format stores called CityTarget, and opened its first three stores in Seattle, Los Angeles and Chicago. Moreover, in order to expand its global footprint, the company is eyeing the Canadian market with an expected entry in 2013.

Other Financial Details

During the quarter, Target bought back about 9.6 million shares at a price of $57.09 per share, aggregating $549 million, and also paid dividends of $198 million.

The company ended the quarter with cash and cash equivalents (including short-term investments of $830 million) of $1,442 million, total unsecured debt and other borrowings of $17,014 million and shareholders’ equity of $15,897 million.

Stores Update

Target currently operates 1,772 stores, of which 428 are general merchandise stores, 1,090 are expanded grocery assortment, 251 are SuperTarget stores and 3 are CityTarget stores.

Strolling Through Guidance

Target now projects adjusted third-quarter 2012 earnings between 83 cents and 93 cents a share. For fiscal 2012, earnings are expected to be in the range of $4.65 to $4.85 per share, up from $4.60 to $4.80 forecasted earlier.

On a GAAP basis, including expenses related to the company’s entry in the Canadian market, management projected earnings between 69 cents and 79 cents for the third quarter and between $4.20 and $4.40 per share for fiscal 2012.

The current Zacks Consensus Estimates for the third quarter and fiscal 2012 are 76 cents and $4.29 per share. Given the company’s guidance range we could witness correction in the Zacks Consensus Estimates in the coming days with analysts revising their estimates to better align with the company’s outlook.

Let’s Conclude

Target's P-fresh remodel program, 5% REDcard Rewards program, City Target stores, The Shops at Target initiatives and its foray into the foreign market are its arsenal to safeguard itself from a continued sluggish economy and retail market.

Target’s efficient marketing, multi-channel strategy, product innovation, compelling pricing strategy, and new merchandise assortments, should drive comparable-store sales 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. The company’s long-term objective is to attain $100 billion or more in sales and $8.00 or more in earnings per share by 2017.

The economy has not yet recovered fully. It is evident that the company’s customers remain sensitive to macroeconomic factors including interest rate hikes, increase in fuel and energy costs, credit availability, unemployment levels, and high household debt levels, which may affect their discretionary spending, and in turn curtail the company’s growth and profitability.

Moreover, a greater concentration of the company’s revenue-generating capabilities in limited regions of the U.S. poses a competitive threat to Target, compared with Wal-Mart Stores Inc. (WMT) and Costco Wholesale Corporation (COST), which are more geographically diverse.

Currently, we maintain our long-term Neutral recommendation on the stock. However, Target retains a Zacks #2 Rank that translates into a short-term Buy rating.

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