Target (TGT) reported strong third-quarter results Wednesday that showed strength in its US retail stores and improved bad debt expense at its credit card operations. We liked the quarter and are maintaining our high $50s fair value estimate.
The firm’s US retail sales jumped 5.4% thanks to a 4.3% increase in comparable-store sales with the balance of the increase coming from new store expansion. The same-store sales increase was Target’s best showing since the second quarter of 2007. Segment earnings (EBIT) jumped over 14% thanks to a 0.4 percentage point improvement in segment operating margins, almost entirely driven by reduced SG&A expenses (as a percentage of sales).
Though we liked the firm’s US retail performance, we were equally pleased with the company’s US credit card results. Target’s third-quarter bad debt expense, though an estimated measure, fell roughly $70 million from the same period a year ago. The company cited “improved trends in key measures of risk”, which suggests to us that the US consumer (or at least Target’s customer base) is becoming more creditworthy. We think Target’s REDcard Rewards program, which offers customers a 5% discount on their purchases, has been a nice driver for the firm, increasing loyalty while bolstering spending. Segment profit in its credit card division jumped 10%, despite overall declines in the size of the portfolio.
All-in, Target’s net earnings jumped 3.7%, while diluted earnings per share increased over 10%, to $0.82 per share, as the firm bought back 4.5 million shares of its common stock during the period. Impressively, if we backed out the firm’s Canadian investments and held Target’s tax rate constant from last year’s quarter, earnings per share would have jumped 28%–a very nice showing.
Looking ahead, the firm expects fourth-quarter diluted earnings per share to come in the range of $1.43 to $1.53 (consensus was at $1.48), which excludes the potential sale of its credit card receivables—the timing of which remains unclear, though management mentioned an announcement should come before CFO Doug Scovanner departs. We also applaud Target’s planned move into Canada in 2013, though currently the strategic expansion is weighing down operating results. Start-up expenses and depreciation, for example, lowered operating income by $35 million in its third quarter.
Long-term, Target expects to generate over $8 per share by 2017 and pay out an annualized dividend per share of $3+ at that time. Our long-term forecasts are below management’s views, and we think the firm has a lot to do to deliver on these projections.