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Jim Cramer's Action Alerts PLUS

Action Alerts PLUS

Target's Analyst Day Does Not Disappoint

By Jim Cramer and Jack Mohr | 03/03/15 - 05:05 PM EST
Stocks in Focus: TGT

Target (TGT:NYSE) CEO Brian Cornell’s first-ever analyst day did not disappoint. It was also not short of surprises. While the company’s 2015 and long-term comparable store sales guidance came in lower than expected, its aggressive share repurchase strategy and earnings algorithm surprised sharply to the upside. We come away from the event incrementally positive and believe Cornell has purposefully set the bar low in order to leave ample room for upside as the year progresses.

Under the stewardship of Cornell, Target has emerged as a more agile, more efficient, and more focused company. This point cannot be overstated. As seen in his decision to quickly exit Canada, we believe Cornell has the rare executive tendency to act swiftly and purposefully. We expect this to be a hallmark of his tenure, and believe the strategy he unveiled today is consistent with such an attitude. By eliminating complexity and facilitating efficiency, he is committed to unleashing and accelerating innovation throughout the company, with the ultimate goal of delivering what guests want.

To that end, following Target’s comprehensive strategic review, management believes it now has a very clear understanding of its shopper, which has increasingly become families (a growing percentage of which are Hispanic) that are digitally connected and value conscious. In fact, Cornell revealed that guests who shop both in-store and through the digital channel drive 3x more traffic, 3x more business, and 2.8x in-store spend as guests who shop exclusively in-store. This means digital engagement does not take away from the store experience, and instead creates more trips and a higher average ticket.

The strategic review also helped management zero in on key merchandise categories. As discussed on the fourth- quarter earnings call, management intends to dedicate outsized time and energy to enhancing Target's signature categories (Style, Baby, Kids and Wellness), which account for $20 billion in sales and have among the most attractive gross margins. The company’s grocery business, while not a signature category, will also play a key role in its overall assortment and ties very closely to its focus on “Wellness.” Guests, according to management, want more choices -- more natural, organic and gluten- free items with simpler, cleaner ingredients and labels.

In order to serve customers in urban, densely populated cities, Target is testing and rolling out new CityTarget and Target Express formats, which boast twice the productivity and high-30% margins.

Now let’s take a peek at Target’s financials. Over the long-term, it expects to grow the top-line in three ways: 1% store channel comparable sales growth; 40% digital channel sales growth CAGR (2015-2019); and modest growth from new stores, most importantly Target Express and CityTarget. We believe management is sandbagging the 1% long-term comp target, which plays perfectly into Cornell’s clear bias towards setting the bar low and surprising to the upside. We would note that the company expects digital to contribute half of the total comp, a long way from the de minimis contribution we saw as early as several quarters ago. For 2015, management is guiding to 2-3% total sales growth, with 1.5% to 2.5% comparable sales growth; for 2016 and beyond, it is guiding to 3% sales, driven by the aforementioned 1% comp.

On the cost side, the company is targeting $2 billion in expected savings over the next two years, which will be immediately reinvested into growth and profitability. It expects EBITDA margins to improve 20-30 basis points year over year in 2015 and is ultimately targeting 9.5% to 10% EBITDA margins over the next five years, which falls roughly in line with consensus. This year, the company expects to invest $2 billion to $2.2 billion in capex, with roughly half coming in the form of IT and the supply chain (in line with its goal of investing heavily in the digital channel). Longer term, it expects to spend $2 billion to $2.5 billion in capex, which is slightly above historical averages.

In regards to capital allocation, the company is targeting a 40% dividend payout ratio by 2019, which is somewhat lower than the current ratio. It plans to increase the dividend 5-10% annually, well below the 20% growth rate achieved over the past five years. While this may seem disappointing, Target’s buyback guidance blew even the most bullish estimates out of the ballpark. Management expects to repurchase $2 billion of shares this year (which compares to our $700 million estimate and $600 million consensus) and $3 billion each year thereafter (which compares to $1.5 billion consensus and represents 6% of the company’s market cap). This adds another, unexpected, dimension to the Target story and makes us confident that earnings will be supported for the foreseeable future. For 2015, these variables lead to adjusted earnings per share guidance of $4.45 to $4.65, which at the midpoint comes in 5 cents higher than consensus.

Overall, we are excited by Target’s analyst day, and believe the company has positioned itself well for the long term. In our view, Cornell “gets it,” and we are impressed by the way in which he has organized, prioritized and communicated his strategy. We believe he is low-balling his comparable store sales guidance (or as we like to say, “setting a one foot hurdle”), not unlike the way in which he low-balled fourth-quarter 2014 guidance, which provides room for material upside as the quarters progress. We expect long-term comparable sales growth to come in twice that of management’s forecast, and believe the added boost from its unparalleled buyback plan can bring real earnings power materially higher than its own forecast. We reiterate our $90 target on shares.

Regards,

Jim Cramer, Portfolio Manager & Jack Mohr, Director of Research - Action Alerts PLUS

DISCLOSURE: At the time of publication, Action Alerts PLUS was long TGT.

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