Target's Recovery Will Take Time, but There Are Better Days Ahead

Target's problems are severe but likely short term. The stock is cheap and could be a Foolish opportunity if the company can get its act together.

May 23, 2014 at 9:33AM

Images

Source: Target.com

It's been a rough year for Target (NYSE:TGT). Its business and brand connection with consumers are starting to show bruises from a series of blows. First, the discount retailer incurred a serious security breach when hackers stole personal information from tens of millions of customers. This resulted in a wave of backlash that has undoubtedly hurt the company's image and eventually cost the CEO his job.

Not surprisingly, Target's stock has languished and basically missed the market rally last year. With the release of the company's first-quarter earnings report , we got confirmation that things are bad for Target. But there may also be an opportunity knocking.

After all, it was already abundantly clear that things were bad. And to a certain extent, Target's earnings report wasn't all that bad considering everything it's going through. Target doesn't have the deep, structural problems that Wal-Mart Stores (NYSE:WMT) is grappling with. And, the stock is cheap, provided the company can get its act together sooner or later.

With a valuation as discounted as its products and a high dividend yield, Target may be shaping up to be a great Foolish opportunity if it can engineer a turnaround.

Results were not as bad as feared
In all, Target posted a 14% drop in adjusted earnings per share in the last quarter, which is surely disappointing on a stand-alone basis. This was accompanied by a 0.3% same-store sales decrease in the United States. Same-store sales measure sales at locations open at least one year.

In addition to the security breach, one of the factors that continues to weigh on Target is its lagging growth initiative in Canada. Target was formerly limited to the United States and began a strategic expansion into Canada as a source of growth. Indeed, sales in Canada soared from $86 million in the first quarter 2013 to $393 million in this year's first quarter.

That doesn't tell the whole story though. Target's venture in Canada is costing the company huge amounts of money. To that end, Target's loss in Canada actually expanded to $211 million last quarter, up from $205 million in the year-ago period. That means that even though Target is racking up impressive sales growth, its costs are still out of control. This is a key area that management must tackle going forward.

As disappointing as it is to see Target post a drop in U.S. same-store sales, it's not as bad as it could have been. Target's results don't signify a serious deterioration of its brand image with consumers. It's going to cost money to fix the security breach and the operating problems in Canada, but the situation that Wal-Mart faces is arguably worse.

Wal-Mart posted a 3.5% drop in profits last quarter, but its problems could last much longer than Target's. Whereas Target can eventually get past its security breach, Wal-Mart is facing a severe public relations backlash surrounding the way it treats its employees. In addition, there have been budget cuts to food stamps, a program that many of Wal-Mart's customers rely on. That's why despite the fact that Target is hurting more now, its long-term future could be brighter than Wal-Marts'. 

Why Target could be Fool's gold
Target cut its full-year forecast after reporting first-quarter earnings, which was yet another disappointment. But it's worth noting that Target has a light at the end of its tunnel.

It expects adjusted EPS to clock in at $3.75 this year, down from prior expectations of $4 per share. After its reduced outlook, Target shares trade for about 15 times forward earnings. Assuming things don't get significantly worse for Target, it looks fairly cheap. Target now offers a 3% dividend yield thanks to its falling share price and habit of increasing its dividend regularly. It's rare for Target to yield that much. in fact, Target hasn't yielded 3% at any point over the past five years. There's no doubt that Target is suffering. But if the company can get its act together, it appears its problems are priced in.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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