testing market sentiment: Target (TGT)

When TGT reported April quarter earnings last month, its balance sheet showed a whopping $4.5 billion increase over the comparable period of the prior fiscal year (note: retailers typically end their fiscal years in January of the following calendar year, in order to get an accurate read on December holiday sales, which can make up the bulk of the year’s income).

TGT has 464 million shares, so that translates into extra merchandise on the balance sheet (at TGT’s cost) of a bit less than $10 a share. The stock lost about $60/share on this news. That’s $28 billion, 30% of its total market capitalization.

Overnight, the company announced, as I see it, that it has decided the best course of action is not to feed this extra into the market slowly but to rid itself of it as fast as possible. My guess is that management has realized that every retailer is in the same boat and, to mix metaphors, the first one out the door will end up recovering the most.

In rough-and-ready terms, TGT typically marks merchandise up by 30% – 50% over cost and achieves an operating profit (meaning after deducting the cost of running its stores) of 6% – 8% of sales revenue.

If TGT could sell the extra at normal margins, it would make $270 million. We know that isn’t going to happen. A good outcome, I think, would be if it can recover what it paid to manufacturers for the TVs, furniture and appliances. Let’s assume it can only achieve $2 billion in cash, suffering a $2.5 billion one-time loss. After-tax, that’s around $2.75 billion, or $6 a share, more or less.

As I’m writing this, TGT has recovered a bit to a loss of $12 a share, or $5.5 billion+, on this news.

To sum up, TGT’s severe misreading of its market will likely cost the company a one-time loss of $6 a share. Maybe there’s some reputational damage, both on the part of shareholders and customers, as well–although my guess is that, if so, the feeling doesn’t last very long. The stock has lost $72 a share on the news, $12 of that so far this morning.

My point?

The hallmarks of a bear market is that investors develop a kind of myopia. Their perspective shrinks to encompass only what’s happening in the here-and-now, and excludes, in particular, consideration of anything good that might happen in the future.

Ex the inventory mess, TGT is trading on 11x earnings. The fact that it continues to go down indicates that bears are still in control of trading on Wall Street.

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