Target: Softer Second-Quarter Results Driven by Weaker Margins

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Tuesday morning, Target updated the company’s expectations for the second quarter. Management is now anticipating adjusted EPS will be about $0.78 in the quarter (a 20% decline versus $0.98 last year). The new outlook is roughly $0.15 below the midpoint of the company’s prior guidance range of $0.85 to $1.00, and below the $0.91 incoming consensus forecast. The updated outlook assumes domestic same-store sales will be flat in the second quarter and EBITDA margins will be lower than previously expected, driven by an increase in promotional markdowns. Given that the Street was only assuming a comp of 0.3% for the period, the majority of the EPS decline is a direct result of a much lower gross margin outlook as promotional activity likely ramped up to drive sales in the quarter.

For the Canadian segment, the company highlighted that it expects sales will be softer than previously forecasted, and the impact from clearing excess inventory will continue to be a detriment to margin results. We are reducing our full year 2014 and 2015 adjusted EPS estimates by $0.20 each, to $3.40 in 2014 and $3.85 in 2015. Our updated outlook anticipates that the EBITDA margin softness in the second quarter will continue in the second half of the year, although we expect the rate of decline to improve modestly. Specifically, we reduced our full-year domestic gross margin estimate by 20 basis points, to 29.2%, to account for more promotional activity.

Along with the new second-quarter outlook, management also provided an update on company expenses related to the data breach. The company now expects to record a gross expense of $148 million in the second quarter, which will be partly offset by $38 million in insurance receivables (net expense of $111 million). These expenses include an increase estimated losses stemming from breach-related claims, but management acknowledges that these estimates may change as new information becomes available.

In addition, Target will recognize a pretax loss of $285 million (or $0.27) related to the retirement of debt. We exclude these items from our adjusted EPS estimates. Given the hiring of new CEO Brian Cornell, announced last week, it is not surprising to see Target lower expectations. However, this reduction has come rather quickly and it remains unclear whether there will be a further earnings rebase as Mr. Cornell implements his corporate strategy.

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