The Slow Decline and Fall of Target

Strangely enough, Target (NYSE: TGT) has something in common with the Roman Empire; it is slowly but surely declining. Target’s fall is not close yet, but it might be in sight when one examines the earnings report and sales figures.

CEO Brian Cornell admitted that in store sales fell by 1.3% during the first quarter of 2017 during the May 17 earnings call, USA Today reported. Yet some analysts were happy because Target’s profits are up, the profit margin rose from 3.95% in January to 4.25% on April 30, 2017.

The problem is that the revenues and income fell despite the growth in profit margin. Revenues dropped from $69.50 billion in January; to $69.32 billion on April 30, 2017. This was the ninth straight quarter of declining revenues at the iconic discounter.

How Accurate are Target’s Sales Figures?

That figure alone suggests that sales at Target might be worse than management is claiming. One problem might be that Target is increasing its sales of higher value items like designer fashions while everything is falling.

Revenue losses at Target have been brutal, down $3.54 billion since April 2016, when Target reported $78.86 billion in that figure. That obviously cannot go forever particularly in today’s Darwinian retail battlefield, where one stumble can send a strong brand into the death spiral.

Another red flag at Target is Net Income; Target reported a net income of $3.36 billion in April 2016, and $2.786 billion in April 2017. That means Target’s income fell by $574 million in a year, so it is apparent the company is making less money.

Target Going Down

Something odd is going on here, and Mr. Market seems to be getting wise to it. Back on January 3, Target was trading at $72.23 a share, by May 24, 2017, the share price was $54.19.

During the first five months of 2017, Target’s market capitalization fell by $10.96 billion declining from $40.86 billion on January 3, to $29.90 billion less than six months later. 2017 is shaping up to be a very brutal year for Target.

Naturally value investors will wonder if Mr. Market’s assessment of Target is correct or not. Is it really a retailer in terminal decline or a value diamond in the rough?

Is Target Making Money?

To try and answer that question I examined Target’s cash, and found few clear answers.

Cash from operations is up considerably which is very good. Target reported $6.492 billion cash from operations; the highest level since April 2013, for the last quarter. That was a $1.898 billion increase over April 2016, when Target reported $4.594 billion in revenues. It was also a $1.056 billion over January 31, 2017, when Target reported $5.436 billion cash from operations.

My guess is that this comes from Target’s emphasis on high-profit online sales. Yet it also appears that Target might be paying a high price for those sales. It is clearly making less money but generating more cash these numbers look a lot like those Walmart (NYSE: WMT) which is in a similar predicament.

Part of the problem is that it costs more to sell online than in stores. Retailers like Target have rigid control over costs in store because of highly developed distribution systems. When they ship an online order retailers are the mercy of UPS, FedEx or the Post Office. That’s why both Walmart and Target are emphasizing in store pickup and looking to delivery options such as Uber.

Target is Keeping Less Money

In such a situation, Target makes more money but keeps less of what it makes. Cash and short-term investments in April 2017 were $2.68 billion compared to $4.036 billion a year earlier; although they were up from $2.512 billion in January 2017.

Free cash flow definitely improved with $817 million April 2017, over -$38 million a year earlier. That was a dramatic drop from January when it was $2.192 billion in January.

It looks as if Target; like Walmart, is going to have to get used to a brave new world of less float and more cash flow. That means higher operations costs, and less flexibility. One result of this is that it will probably have to start closing stores or reducing their size at some point.

Target is a Poor Investment

All this means that Target is a really poor investment right now because of the share price collapse.

The return on equity for April 30, 2017, was good at 24.37% but I do not see how that can be maintained next quarter. Nor do I think the 60¢ dividend Target paid on May 15 can be maintained.

Sell Target now because this stock and the company that issues it are sure to decline in the foreseeable future. Expect to see Target fall to new lows in coming quarters, as the revenue keeps declining.