2/23/2010
By Brian Sozzi, Research Analyst

More Articles by Brian Sozzi

As detailed could happen in our pre-earnings note, Target Corp. (TGT) posted a "strong" beat to the 4Q09 EPS consensus.  The company comped positive for the quarter, +0.6%, the first positive comp since 4Q07 (+0.2%).  Breaking down the comp, it was encouraging that the number of transactions (+2%) and units per transaction (+0.9%) were positive, reversing steep declines during the dreadful holiday season of 2008.  We believe the performance of these two metrics are important indicators of Target's business positioning moving out of the recession, both of which suggest Target's patrons have increased their visits and are more willing/able to spend on non-essential merchandise.  In fact, comps ranged from -2% to +5% for Target's home and apparel categories, and critically, Target's management better sourced the products and planned the buys more effectively.  Assuming consumable goods inflation returns sometime in 1H10, and Target maintains its traffic, a friendlier comp backdrop for the Company is likely to ensue keeping in mind comp declines in 1Q09, 2Q09, and 3Q09.  Moreover, Target must continue to drive comp in discretionary categories, remove supply chain costs, and focus on private label (33% of the business) if it desires to offset the expenses associated with its remodeling efforts.

Target plans to remodel 350 stores this year, adding the "P Fresh" food format and upgrading the games, beauty, and home departments.  Although most of the costs are to be capitalized, we sense a concern in the market as to whether Target could achieve EPS upside amid the numerous initiatives on the horizon.  This concern was fleshed out within management's 1Q10 EPS guidance; consensus EPS of $0.76 was noted at the "middle of the road" of a likely outcome, a slight warning in our view as Target will remodel a significant amount of stores in the quarter.  Nevertheless, February comps are on track to be positive for the third consecutive month, telling of the momentum in the business given storm activity throughout the U.S.

The market's concerns are well founded, but we still envision a path for Target's earnings that end FY10 higher than consensus expectations.  Key margin driving departments continue to turn the corner, expense discipline in the Retail segment has certainly been there, and the resumption of share repurchases is an earnings tailwind.  We view favorably the "P Fresh" initiative, though the business does throw off a lower gross margin relative to Target's overall gross margin (21% for "P Fresh", 29% overall).  However, "P Fresh" does generate stronger EBIT margins.  Continued credit card normalization, at least until 2H10, is an added input to our modeling.

Shares of Target trade on a PE multiple of 10.5x based on our EPS est. for FY11, about a 35% discount to the mid-point of the valuation range of the last eight years.  In light of encouraging trends in the business we have applied a 14.0x PE multiple (nearer historical average) to our FY11 EPS est., rendering a price target of $68.00.

Brian Sozzi
Wall Street Strategies