Why Target's Turnaround Story May Be Over

Target has survived a crisis. Now what?

Getty Images/Moment Mobile/Diane Macdonald

Over the past year, Target CEO Brian Cornell has embarked on an ambitious turnaround plan that has garnered the praise of analyst. Cornell has made a few smart moves to help Target turn the page from its cyber attack scandal and he has stabilized the chains earnings. Yet, with shares at fresh 52 week highs, this turnaround story may have limited upside from here.  Here's why.

Surviving doesn't warrant a lofty valuation


Target has reported a few good quarters by passing a very low bar.

A year ago, Target was in freefall, reporting double-digit EPS decline in consecutive quarters. This year, Target's year over year profit growth has soared, mostly because it's being compared to last year's cyber attack affected numbers. Yet comparable store sales growth has been 3.8% and 2.3% in its most recent quarters; solid numbers but not robust considering last years weak comparisons. Foot traffic at stores is not exploding, yet Target's stock price has because investors nerves have settled. 

Target's stock is up 42% over the past twelve months. Naturally, that is mostly a rebound because a catastrophe was averted. With a forward P/E ratio of 16 and a PEG of 1.40, the stock is not necessarily overvalued but it is trading at about fair value and near its historic range. In other words, investors who bought Target during its crisis period have profited thanks to its stabilization. With the stock now fairly valued, organic growth will be needed to help the stock price soar from here.

If Target's pedestrian comparable sales growth is any indication, that may not be easy. 

Target's Canadian exit is smart...and scary


Another move that has helped Targets stock, was the retailer's stunning exit from Canada in January. After analyzing its Canadian operation, Cornell decided that Target wouldn't have turned a profit in Canada until 2021.

Scrapping the losing operation earned kudos from analysts, but it also raises questions about Target's growth.

In a statement, Cornell mentioned that the final decision was made in part because a turnaround was not seen in the holiday season. But after publicly stating how difficult a turnaround would be, is a single quarter a long enough time to wait before closing down the operation? How could Cornell really tell that it would take six years to make Target Canada profitable after one quarter? Further, is six years really too long for a turnaround? It's hard to answer these questions, but on some level it seems management took the path of short-term profits over growth. 

The only rationale that really makes sense is that Canada was just unsalvageable. Analysts largely point to the lack of an effective distribution network as Target's downfall in Canada. This is blamed for understocked shelves and inconsistent pricing, but if that was the only problem management likely would have invested in a solution. The fact that Target cut bait leads me to believe that the brand didn't resonate in Canada. 

While Canada has been a tough market for several retailers, Targets failure does raise questions about its international growth prospects.

The chain is largely dependent on the U.S., in which it has saturated most markets already. In the near-term, Target's balance sheet will benefit from its Canadian exit and it will focus on smaller stores in urban markets for growth. That's a fine plan in the short-run but, again, investors buying today may face a ceiling in the stock price without international growth. The growth prospects in the U.S. are too limiting to value Target's stock as a growth company.

Target may very well expand successfully into another foreign market down the line. But for now, it's one bold international growth move, Canada, was cut only two years into the experiment. Further, management gave mixed messages throughout when it came to Canada's prospects and never seemed to have a handle on it from an operational standpoint.

Know what to expect from your stocks


Even if you don't own Target's stock, you can learn something from this exercise. Target is a fine company and I believe it will do fine for some time. The sky is not falling. But you have to know what to expect from your stocks; investors who expect Target's turnaround story to continue might be disappointed. If the stock pushes any higher without a dramatic upswing in earnings, it will be overvalued. Yet, with most U.S. markets already saturated with Target stores, and no reason for same-store sales to spike, why should anyone expect shares to go much higher?

Peter Lynch once said that stocks only make big moves for two reasons: "a small company becomes a big company, or a poor performing company turns around." The latter happened at Target over the past year. The turn has happened, now the company must grow.