• Eric Sprott Suggests Shortsellers Ruined Public Debut of Sprott, Inc.
  May 16 2008 1:35 PM

August 20, 2008 10:55 AM
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Target is trading with a 5-handle again...is there more to come on the upside?

Target is managing very well, but profitable "discretionary" goods still lag. Credit seems to be finding a lower bottom than earlier expected. Despite better-than-expected 2Q EPS, we cut 2008E from $3.57 to $3.50 (versus $3.35). Mix-related margin pressure and less improved expense benefit compound high (though moderating) Credit provisions to reduce 3Q08E a few pennies. 4Q08 should be a little better... and look a lot better when leveraged by faster-than-expected share retirements (because the interest cost of reducing shares is swamped by high 4Q seasonal profitability).

KEY POINTS:

Despite a worse-than-expected collapse in Credit income, good expense control allowed Target to deliver a surprisingly good second quarter. 3Q08 will likely be softer, and 4Q08 may not be as robust as we thought. Last year, business fell off from a very good August, and even with 2%-ish comps for September and October (preserving trends like August's expected 2% decline), 3Q08 comps may rise only 0.5% (previously 2%). With continued mix-related margin pressure, we believe Merchandising will not compare as favorably as previously thought. Worse, write-offs should remain high (into next year, too), while steps taken to moderate or offset that pressure may not really take hold until 4Q08. 3Q08E EPS is cut from $0.60 to $0.53 (versus $0.56). 4Q08 comps of 2% (from 4%) will make Merchandising's 4Q recovery less robust than previously thought. As part of the cure for those higher write-offs, receivables growth is expected to slow even more sharply while the improving yields (from changed lending terms) might not offset the still higher-than-prior-year provisions (that may prevail into early 2009). 4Q08E EPS is cut from $1.48 to $1.42 (versus $1.23).

Surprise! Target reduces near-term new-store plan! Partly because third-party development of retail centers will be slow again next year (because of the lack of financing or the inability to lease in-line space), and partly because, in the current environment, some proposed stores no longer meet the company's ROI criteria, only 70-75 (net) store openings are planned for 2009, compared to more than 90 this year and more than 100 in 2007. We have reduced 2009E revenue by over $1 billion... but with reduced cannibalization, moderating organizational stress from store openings, etc., and the likelihood
of declining write-offs in Credit, all leveraged to significantly fewer shares (previously-assumed '09 shares of 752 million might be 715-720 million), 2009E EPS has been reduced surprisingly little, from $4.20 to $4.10-4.15.

Credit EBIT returns on investment may well have troughed in the quarter just reported and could improve consistently going forward... though "good" returns may not appear until 2010. Meanwhile, we believe returns are being very well managed in "retail." Target's overall ROIs still appear to be on an improving track, the same improving track that led us to our $65 12-month price target.

We continue to rate the shares Buy.

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