Target Confirms Weak Start: Should You Sell?


One of the biggest stories in retail this month was the set of leaked internal Wal-Mart emails about weak sales trends in January and early February. As I wrote earlier this month, the weak sales data from Wal-Mart were a natural consequence of the recent payroll tax increase, government spending cuts, and rising gas prices. I expected other mass retailers to see a similar hit.

On its earnings call Wednesday morning, Target's management seemed to confirm that the consumer spending environment has been weak in early 2013. Target is projecting that sales growth will pick up in the middle of the year, but this forecast may be too aggressive in light of continued headwinds from higher payroll taxes and government fiscal austerity. As a result, downside risks seem to outweigh the potential upside for Target shareholders for now.

Slow growth continues
The U.S. economy has been growing at a snail's pace recently, with fourth-quarter GDP being revised to just 0.1%, due in part to government spending cuts and worries about the fiscal cliff. If anything, headwinds are increasing. The government is on the brink of cutting spending by $85 billion over the next seven months, which (according to the Congressional Budget Office) could result in the loss of 750,000 jobs and reduce economic growth by 0.6% or more. Target relies heavily on selling to working-class and middle-class consumers. People in these socioeconomic groups are more likely to be affected by the expected reduction in government spending than wealthier Americans.

In light of the continuing headwinds to economic growth, Target's forecast was somewhat puzzling. The company projected same-store sales to be flat to up 2% this quarter, but up by around 2.7% for the full year. Part of this can be explained by tougher comparable figures from last year in the first quarter. However, Target's management also seems to be confident that as far as the U.S. economy is concerned, the worst is behind us. Given the government's apparent inability to avoid the coming sequester, a more cautious view is warranted. If no solution is agreed upon before government layoffs and furloughs begin in April, consumer confidence could drop precipitously, putting Target's sales forecast at risk.

Better days ahead?
In the longer term, I am actually excited about Target's growth potential as it enters Canada, as well as about other future international expansion opportunities. However, while the Canadian stores are expected to be profitable in the seasonally stronger fourth quarter this year, they may not post a full year of profitability until 2015 or later. Earnings growth from international expansion will help Target in the long run, not immediately. Target could therefore be an attractive longer-term growth play if economic weakness knocks shares down this year. However, the company appears fairly valued at present, in light of the potential for sluggish U.S. sales growth.

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