Target Corp. (TGT US) reported disappointing 4th quarter results with sales hitting analysts’ estimates at $20.7 billion, but EPS falling $0.06 below estimates at $1.45. CEO Brian Cornell admitted that Target’s weak holiday sales were not just a temporary slide in demand and adjusted both 1st quarter EPS guidance, $0.80-$1.00 vs. estimates of $1.33, and full year guidance, $3.80-$4.20 vs. estimates of $5.34. Target was down 13% in early morning trading.
There is a new reality in the multi-line retail sector – shrinking margins and increased e-commerce sales activity, which is forcing higher Capex expenditures while maintaining high fixed costs in the brick and mortar space. Internet retailer Amazon.com Inc. (AMZN US) and behemoth Wal-Mart Stores Inc. (WMT US) are forcing traditional retailers to match prices and build out their e-commerce capabilities in order to compete for market share, which has bled away from their physical locations. Retailers who depended on strong foot traffic and higher margins to support their infrastructure and staff are being forced to find ways to cut costs, increase margins and eliminate underperforming locations. Discount retailers who have already minimized costs and maximized efficiencies to be successful low margin entities have not been affected nearly as much.
The difference between discount retailers and traditional retailers is reflected in this year’s short side winners and losers in the multi-line retail sector. Traders have been profitable shorting the big name, full price, high fixed costs traditional retailers and have lost money shorting the already low margin discount retailers. The top five most profitable 2017 YTD short trades were all traditional brick and mortar retailers while the top five least profitable 2017 YTD short trades were all discount retailers.
A $100 million pairs trade, which would be long $20 million of each of the discount retailers and short $20 million of each of the full price retailers, would have generated approximately (depending on portfolio’s financing costs) a +20.5% YTD return net of stock borrow and margin financing costs.
For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC
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