Time to Sell Target? 3 Things You Need to Know
Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
At Motley Fool CAPS, we follow a lot of analysts --216 name-brand equity researchers, brokers, investments bankers, hedge fund managers, and TV talking headsat last count. Over the past decade, however, Gordon Haskett Research is one researcher we havenothad opportunity to review before. (Probably because, according to data fromStreetInsider.comat least, Gordon Haskett only began publishing stock ratings around the middle of last month.)
That could soon change -- because Gordon Haskett is storming onto Wall Street today with no fewer than 10 brand-new stock ratings in the retail sector. Of these, a couple stand out for their audacity: a big buy rating onWal-Mart(NYSE: WMT), and an even bigger recommendation to sell Wal-Mart's archrival,Target(NYSE: TGT).
Here are three things you need to know about these ratings.
One analyst just painted a bullseye on Target. Image source: Getty Images.
1. Setting up the Target
Tuesday dawned dark and foreboding for shareholders of Target stock, when Gordon Haskett put out a very negative note on the retailer -- a retailer that, one gets the impression, GH would really like to see succeed, but fears will fail instead.
GH lays out its sell thesis by first accentuating the positive. Target has a relatively new CEO in Brian Cornell, and Cornell is making "all the right decisions" to try to save Target from the twin threats posed byAmazon.com(NASDAQ: AMZN)in e-tail, and Wal-Mart (in both e-tail and retail). Already, Target has reset its earnings guidance for the current year, such that analysts are now on the same page, and predicting declining same-store sales and profits of only about $4 a share this fiscal year.
Target plans to spend about $1 billion this year on remodeling stores and cutting prices on its wares (to better compete with Wal-Mart). It's also positioned to profit from the wave of smaller retailers (Gander Mountain, hhgregg, and Limited Stores, just to name a few) going out of business and leaving their customers with few options (other than Target) to shop at.
2. Trashing Target
That's the good news. Now here's the bad.
Target is "moving ... too slow" to fix what's wrong with it. More importantly, Gordon Haskett has seen this movie before, where retailers such as Kroger and Wal-Mart itself had to remake their business models and lower their prices to better compete in the age of Amazon. But GH notes ominously that it took Kroger "several years" to accomplish its makeover, and Wal-Mart "2+ years to get its act together."
Thus, while many analysts are taking it on faith that Target will right its ship within this year, and won't need to spend more than $1 billion to fix its business, GH is not sold on that idea. Rather, the analyst worries that this "will likely be a multi-year journey" and one that will depress Target's earnings for years to come. In the very short term, GH warns that Wall Street's expectation of a return to profits growth ($4.03 in earnings projected for fiscal 2018) is overoptimistic, and earnings could instead decline 10% next year (to $3.60).
If and when that happens, Target shareholders could be in for a shock. GH advises the better move is to sell the stock today, rather than be unpleasantly surprised by its performance next year.
3. And picking Wal-Mart instead
What should an investor buyinsteadof Target? Gordon Haskett modestly suggests Target's biggest brick-and-mortar competitor: Wal-Mart.
In a buy recommendation out this morning, positing a $90 price target for Wal-Mart stock, GH argues that the once-reviled retailer "is not your father's Wal-Mart anymore." Rather, Wal-Mart is "building a digital ecosystem that should have tangible benefits across the enterprise," and help the company to compete better against not just Target, but Amazon.com as well. Investments in IT, says GH, are giving Wal-Mart advantages in better "access to customer data" and creating "cross-over benefits for in-store traffic."
And the proof is in the pudding: Whereas Target's same-store sales are dropping, GH notes that Wal-Mart is growing same-store sales, and in particular, attracting more millennial shoppers to its stores.
What it means to investors
While Target's profits slump, Gordon Haskett sees Wal-Mart's earnings rising, and even exceeding other analyst estimates. This year, GH predicts that Wal-Mart will earn about $4.37 per diluted share ($0.05 more than the Wall Street consensus). That would price the stock at about 17.6 times current-year earnings at Wal-Mart's share price today. What's more, GH says its predictions could prove "a touch conservative" -- in which case, Wal-Mart's stock is even cheaper than it looks.
Granted, GH's prediction of $4 profits at Target implies a valuation of only 14.5 times earnings on that stock, which suggests Target may be cheaper than Wal-Mart. But remember that GH thinks Target's profits aredeclining, while Wal-Mart's are growing. If that's the case, then Wal-Mart really could be the better deal even at a steeper valuation.
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Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.