Target Misses The Mark: Is It Too Late To Sell?

Key Points

• Target had a mixed quarter, and the market reacted favorably, but the move may not last.
• The guidance was lowered despite the Q2 earnings strength suggesting that this year's strength is priced.
• The dividend is reliable but may be cheaper to buy later in the year. 

Target NYSE: TGT shares surged about 10% after the Q2 earnings report was released but don’t read too much into the news. The surge is a knee-jerk reaction to a mixed report that does nothing to improve the outlook. If anything, the Q2 strengths are 1-offs that won’t persist in the following quarters, and this year’s strength has been seen.

This echoes Home Depot NYSE: HD) news reaffirming guidance despite its Q2 strength. Target lowered its guidance which means the 2nd half will be much worse than previously forecast. In this light, investors should expect the downward trend in analyst sentiment to continue and for Target shares to hit new lows.

The analysts weren’t optimistic about Target’s prospects going into the report. Signs the company was less-attractive to price-conscious shoppers have emerged for the last few quarters and are seen in the top-line figures. That resulted in downward rating and price target revisions, with the Marketbeat.com consensus trending lower.

As it is, Target is pegged at Hold, down from Moderate Buy, with a price target lower than last month, last quarter, and last year. The current $171 consensus figure implies about 30% of upside for the market but is trending lower, and the freshest targets are less optimistic. The good news is that even the low price target of $130 is above the current action, but that may change due to the new guidance. 

Target Has Mixed Quarter: Shares Rise 

Target had a mixed quarter in which revenue fell -4.90% compared to last year and missed the consensus mark by 160 basis points but outperformed on the bottom line. The sales decline is due to a -5.4% decline in comp store sales offset by adding new stores. Comp sales, evidence of flagging consumer engagement, are down due to a 4.8% decline in transactions and a 0.7% decline in average tickets.

Within the revenue data, strength in the Essentials & Beauty and Food & Beverage segments only partially offset the discretionary categories' decline. Digital traffic remains a business driver, with same-day up 4% and drive-up up 7%. 

The margin news is good due to the gross margin and operating margin improvement. Gross margin improved on fewer mark-downs, improved inventory position, lower freight costs, and higher prices. SG&A increased on deleveraging and higher slippage, but the operating margin was improved by 300 basis points.

The bad news is that a fair amount of that improvement is due to the 17% decline in inventory that cannot be relied on for future strength, and that is seen in the guidance. So, the $1.80 in adjusted EPS beat by $0.38 despite the top line weakness but Q3 and Q4 will be worse than previously expected. 

Target lowered its guidance for Q3 and the 2nd half significantly. The company lowered the revenue outlook to -5% +/- with EPS of $7.00 to $8.00. That’s $0.75 lower than the previous range, putting the consensus $7.80 well above the mid-point. Q3 is expected to produce $1.20 to $1.60 in adjusted EPS compared to the $2.42 consensus figure, which may be optimistic. 

Target’s Dividend Is Safe, But It May Get Cheaper 

Target’s 3.5% dividend is safe, but it may get cheaper. The guidance gives little reason to rally and multiple reasons for another price decline which could break significant support targets. Either way, the company is paying out about 63% of earnings at the low end of guidance, so another dividend increase should also be expected.

It may not be large, but the company can continue building on its 52 years of sustained annual distribution increases. 

The chart isn’t promising. The price action has been trending lower and recently retested critical support at a long-term low.

The action is rebounding from that level now but showing some signs of resistance at the 150-day moving average; if the market can not sustain this level, a retest of the recent and new lows is very likely.