Why Target's Earnings Warning Isn't Pummeling the Stock

Updated from 9:08 a.m. with additional commentary from Target

NEW YORK (TheStreet) -- Target (TGT)  missed the mark financially in the second quarter as it continued to deal with soft customer traffic and pressured profit margins following a data breach during the 2013 holiday season.

Click the video below for more on Target's earnings fall:

 


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Despite the disappointing quarter and a full-year earnings warning, Target shares were advancing 1.1% to $59.17 in trading on Wednesday. Investors should attribute that to gushing optimism from management at the retailer and market psychology.

Target reported second-quarter adjusted earnings of 78 cents a share, in line with its lowered guidance from Aug. 5 and the Bloomberg consensus forecast. Target earlier this month said it expected second-quarter earnings of "within a range around 78 cents a share" compared with a prior outlook for 85 cents a share to $1 a share.  

Net sales were $17.4 billion, eclipsing the Bloomberg consensus estimate of $17.36 billion, and were paced by unchanged domestic same-store sales. By department, Target had the most success in its less discretionary merchandise categories, such as toys and electronics. Sales of apparel and home goods declined.

Domestic same-store sales were consistent with the company's guidance earlier this month. Target's domestic traffic has fallen for nine straight quarters.

See More: 12 Photos That Show How Macy's Is Dismantling Sears

Target Canada had another challenging quarter. Same-store sales declined 11.4%, and gross profit margins fell to 18.4% from 31.6% a year earlier as the company marked down excess inventory. Noteworthy was an 8% decline in units per transaction on the part of customers even as Target aggressively marked down merchandise. 

Target Canada has now incurred a staggering $2.14 billion in operating losses since the company began to build the division in 2011.

Target also issued a full-year earnings warning, guiding to full-year adjusted earnings of $3.10 to $3.30 a share, down from guidance provided in May of $3.60 to $3.90 a share.  The warning mirrored what Wall Street heard from Walmart (WMT)  on Aug. 14. Walmart stated that it expects full-year earnings "to range between $4.90 and $5.15 a share, vs. previous guidance of $5.10 to $5.45 a share. 
Despite the negative news, Target shares didn't respond harshly as many investors would have expected. Chalk that up to optimism by the management team on the earnings call, including new CEO Brian Cornell, and market psychology 101. Target stated that "in the U.S., traffic trends continue to recover and monthly sales are improving, with July comparable sales up more than 1%," creating early interest on the part of investors that Target is lowering prices and is starting to bring traffic back to the store right before the critical holiday selling season. 

Another aspect is the "kitchen sink theory," whereby a company's financial results are so dour they are unlikely to be any worse moving forward, and could be priced into the stock's valuation. For Target, this theory would apply to its Canadian division, with the company noting that "in Canada, the team is making important changes to operations and the merchandise assortment with a focus on delivering improved results by this holiday season." Cornell stressed the company has a "comprehensive" review underway for fixing the Canadian business, and expects "improved" performance during the upcoming holiday season.

Target said on the earnings call that it experienced "positive comps in the last six weeks in the U.S.," supported by consumer interest in new products, not just departments with various clearance price offerings.

My firm, Belus Capital Advisors, rates Target a sell.

Watch More: Walmart's Financial Problems Explained in 5 Photos and One Vine Video
  

At the time of publication, the author held no positions in any of the stocks mentioned. This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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