Motley Fool Hidden Gems Investing - Target Misses the Mark

Episode Date: November 20, 2024

The retailer is trying to be everything for everyone. That’s a pretty tall order. Is Target up for the task? (00:14) Jason Moser and Mary Long discuss earnings from Target and TJX, plus: - The state of the consumer heading into the holiday shopping season. - What it takes to build out a true omnichannel operation. - How management teams land on forward guidance. Then, (14:45) Yasser el-Shimy and Ricky Mulvey take a look at Warner Brothers Discovery and debate whether the streaming stock is a steal. Learn more about the Range Rover Sport at www.landroverusa.com Companies discussed: TGT, WMT, TJX, AMZN, WBD, NFLX Host: Mary Long Guests: Jason Moser, Yasser el-Shimy, Ricky Mulvey Engineers: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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Motley Fool Money starts now. I'm Mary Long, joined today by Jason Moser. J-Mo, lovely to see you. How are you doing? Always happy to be here. I'm doing great. How are you, Mary? Doing pretty well. Doing pretty well. As we were discussing before we started recording, I didn't have any eggs for my breakfast today. But despite that fact, I'm fueled and I'm ready to go. Good. Good.

So we're going to take a look at the American consumer today because we had some earnings yesterday from Walmart. Today, we got Target plus another retail company. It's always kind of interesting to me to see how different retailers stack up, whereas Walmart earnings yesterday were strong. Target showed lower sales, lower profit, a little too much unsold inventory. Stock is down nearly 20% last I checked this morning as a result of all that. Brian Cornell, the CEO, he blamed a lot of this on, quote, a challenging operating environment. And, quote, what's he mean by that? Why doesn't Walmart seem to have been affected by the same environment?

Yeah, well, I mean, this does seem like something we've heard a lot over the last several quarters, right? The challenged consumer. And I think that's really what most of this is all about, is just consumers continue to spend very cautiously, and I think most notably in discretionary categories. And unfortunately for Target, that's kind of a place where they need to shine. He did refer in the call to consumer behavior being somewhat cautious, but he also did speak to – remember the dock worker strike? We talked about that several weeks back, right? And that was a situation where we thought it could have dragged on a little bit longer than it did, but I think in regards to Target, I mean, management saw that and they thought, okay, let's try to prepare for the worst and then hope for the best. So they pulled in a lot of inventory to prepare for potential shortages. And that probably was the right decision. But I think it resulted in a little bit of a short term shortfall. He used this term and I thought it was funny. He said they were a little bit fuller than usual, right? They don't operate quite as efficiently when they're so full.

And when he's talking about being full, he's talking about their inventory, right? They tried to bring in more inventory to make sure they didn't run into shortages. We've seen over the last couple of years how those shortages can impact these businesses. And if you look at their inventory levels, inventory was up about 3% from a year ago. So certainly, I mean, it does make sense, right? They just tried to make sure they didn't fall prey to that shortage issue that certainly could have happened if the dock worker strike persisted. Thankfully, it didn't. And that is all resolved, at least for now. But I think those are the things that really contributed to these results and perhaps, you know, that forward guidance as well. A big story with Target even a couple of years ago was their struggles with inventory, and they were able to correct that. Does Cornell have a pretty good playbook for how to right-size inventory moving forward? Or is this something that maybe we should be a little bit nervous going ahead?

No, I think he does. I mean, I think any CEO worth his or her salt knows that, I mean, inventory in this game, when you're talking about big box retailers, I mean, inventory is just one of the tougher parts of managing these businesses. And it ebbs and flows, right? It's not just some sort of constant line one way or the other. And so you see some good stretches and some bad stretches. I think overall, he's done a very good job of managing this business. With that said, it is something worth keeping in mind. I want to zoom in on a couple metrics that at least stuck out to me. So traffic within stores was up about 2.5%,

but in-store comp sales down about 2% for the quarter. So you've got more people coming to the store, but those people are buying less. What kind of a problem is that for Target, and how do you fix it? Is this a merchandising issue? Is it more an indicator of a macro problem, something else? Well, I definitely don't think this is just a target specific issue. I mean, you noted a good point there. I mean, traffic was up, however, comps down. And if we look at tickets, I mean, there was a 2% decline in average tickets. So yes, people are spending less. And if we go back to a point that he noted in the call, consumers are becoming increasingly resourceful. And he made this point time and time again. I mean, they know that there are deals out there. I mean, consumers everywhere, we're all looking for deals. And now it seems like more than ever, we consumers are willing to wait and be a little bit more patient and try to find those deals. And we're willing to look, we're willing to search across multiple retailers to find those deals.

And so that's something that plays into not only a target, I mean, it plays into virtually every one of these retailers. And so it's something that they're going to have to deal with. So while you had same store in-store sales decline, comparable digital sales rose about 11%. But the thing is that those sales have a higher cost of fulfillment, and that drew down Target's operating margin. Can you help me make sense of this? Because I thought we were supposed to believe that digital ordering is more efficient. It's the future. That's how you can kind of you can trim expenses a bit. But that doesn't seem to be what's actually happening here. Well, I think you're right. Digital ordering is the future for the most part, and it can be more efficient depending on the operation. But I think this really goes to scale, right? Scale, I think, is sort of the word here that comes into play. And so to me, you think of e-commerce giants in this space. I mean, the obvious one being Amazon, right? I mean, for so long, Amazon was just in the business of ultimately kind of losing money, right? And everybody kind of wondered, how in the world is Amazon garnering this valuation when they're not making any money? And I mean, the short answer was they were really building out this e-commerce operation and thinking longer term. But look at some of the younger e-commerce players today, right? I mean, think of companies like Chewy, right? Chewy, still working towards really getting that model towards sustainable and growing

profitability. Wayfair, another good example. Same thing. They're just in very early days in building out the infrastructure that is required to ultimately exploit and take advantage of that e-commerce model. because it ultimately can be very profitable, particularly if you have membership models that keep people coming back for more.

But it just takes a lot of money in the early days to get that infrastructure in place. And when we talk about these legacy brick and mortars, which Target is one of those, it's just, it's a lot of work. So I think they're absolutely making the right call and doing it, but there will be some hiccups along the way for sure.

It kind of seems to me like Target is at a little bit of a fork in the road. And you've got two paths ahead of it. One is kind of being chartered by Amazon and Walmart, these two big e-commerce players. On the other path, you've got like the TJX stores, which we're going to talk about more in a second. And while they have online ordering, they really play more to this in-person treasure hunt style type approach. I see Target as kind of straddling both of those styles and kind of being in the middle. On the one hand, you could think that that's a massive opportunity for them. On the other hand, OK, look at their stock this morning. It's down over 20 percent on the latest performance.

Does Target have to pick one path over another or can it can it actually create a strategic advantage by being in the middle of those two plays? I think in Target's case, they don't have to choose one path or the other. And I think part of that is just due to the nature of what Target does. Right. I mean, they they shine in discretionary and they also they also are taking advantage of the grocery space. We talk about companies like Walmart. I mean, one of one of Walmart's biggest advantages and beyond the scale that the company has is that they have such a large presence in grocery, for example, and Target does also participate in that grocery segment. And that I think is really important. I think for businesses like Target, uh, and Walmart and

others, the ultimate key is going to, they're going to need to focus on, on that, that word omni-channel, right? And we've, we've heard that, that word many, many quarters, many, many over many, many years now, Home Depot, Target, Walmart, the like, they are focusing on being omni-channel. I think for legacy brick and mortars, that's been the real big pivot, right? Amazon, for example, didn't really have to worry about the omni-channel thing because they were never really born from being a brick and mortar that had to make that pivot. When you have your Walmarts and Targets of the world that are having to make that pivot, that's fine. They can do that. But I think for these businesses to ultimately be successful, it's less about choosing one or the other and ultimately trying to figure out how to be something for everyone or everything for everyone.

Right. But that's ultimately what Omnichannel is, whether it's folks going in the store, whether it's ordering online and having it delivered or whether it's ordering online and going to the store and picking it up in the parking lot. That is a very difficult strategy. It's very costly in the near term. It's very difficult, I think, in the early days for these legacy brick and mortars. But again, I think it is the right strategy to continue focusing on that on the channel strategy. I want to talk for a second about guidance. Backward-looking accounting is an art in and of itself, but forward-looking projections, in that you're thinking not just about numbers and what it makes sense to estimate moving forward based on what's already happened in the past, but you've also got to think about PR, investor relations, how you communicate these changes that you're anticipating, be they positive or negative. I'm asking about this because this morning, Target cut its full year guidance, but just three months ago, in the last quarter, the company raised its guidance. So how exactly does management land on these forecasts? And what kind of game are they playing in spelling that out for investors? Well, it's definitely an art form for sure.

And I wouldn't put them all in the same sort of sandbox, so to speak. I mean, I think, you know, you've got some companies that prefer a sandbag. They want to set low expectations and then try to exceed those expectations. But ultimately, I mean, these companies are, they're going with the data that they have at the moment, right? I mean, these management teams are just going with the data that they have at the time. And it's always worth remembering, quarter in and quarter out, you see things change, right?

The dock worker strike, I think, is a great example of something that wasn't necessarily foreseen. It came as a little bit of a surprise. And I think we could all argue that it was a little bit of a surprise that it was resolved so quickly, at least in the near term. I think there's still some things that they're trying to work out there. But, yeah, I mean, it's absolutely more of an art form when it comes to forward-looking guidance. And I think the best thing investors can do in regard to that is just paying attention to what these management teams say kind of over the stretch of earnings seasons, right? Look at a full year's worth of earnings releases.

Look at two years worth of earnings releases and see how do these management teams approach that forward guidance? Because there's some companies out there that just really try to stay away from that guidance because they're like, we don't want to play that game. We're trying to create a little bit more of a shareholder base that's focused on that longer haul as opposed to sort of that quarter by quarter game that these teams play. So it absolutely is worth remembering that not every company is the same in this regard. I want to turn real quickly to another retailer, this one, TJX. That's the parent company of TJ Maxx, Marshalls, HomeGoods, Sierra, a number of retailers. They reported this morning as well, reported higher sales, higher net income, spoke about, quote, a strong start to the holiday shopping season. And yet, Vantagement lowered EPS guidance for the fourth quarter. So why is this? If the CEO can say, hey, the holiday shopping season's off to a great start, but we're actually not expecting great stuff moving forward. How do those two things work together? Well, and that's interesting because it seems like they're looking at the fourth quarter as perhaps a little bit more challenging. There's some costs flowing through the business that weren't necessarily reflected from a year ago. And that's just something we know is always going to come into play. I think it's worth noting that they did actually bump up earnings per share guidance for the full

year. So, you know, we're looking at fourth quarter versus the entire year. I mean, if we look back to just a quarter ago, they had called for earnings per share for the full year in the $4.09 to $4.13 range. In this quarter, they actually bumped that up to $4.15 to $4.17. sense. So I think I wouldn't worry so much about the nitpicking on the quarter. Again, TJ Maxx and TJX companies, they're a company that are definitely going to be dealing with a more challenged consumer. It's always funny to me to hear them talk about the weather. Weather is one of those things that every retailer is going to have to deal with, but I guess it impacts them more than others. But again, I mean, I think you look at that

fourth quarter guide, maybe it's a little bit lower than what analysts were looking for. But as I've said on this show before, I'm not necessarily so worried about what analysts are looking for. I generally focus more on what management is calling for and then making sure that management is hitting those goals that they set. Jason Moser, always a pleasure talking to you. Thanks so much for taking the time to come onto the show this morning and for giving us some more insight into these two companies. Thank you. While investors are optimistic about the future of Netflix, Warner Brothers Discovery, the

owner of Max and HBO, is in the bargain bin. My colleague, Ricky Mulvey, caught up with Fool senior analyst Yasser El-Shimi to talk about the value drivers for Warner Brothers Discovery and if the stock is cheap for good reasons. from morning hockey with a cup of coffee to timbits and road trips tim's and canadian tire have always gone together now it's official you can now earn canadian tire money at tim's link your triangle rewards and tim's rewards accounts to earn twice with every tim's run terms and conditions apply visit tim hordens.ca triangle for details so yasser do you have like

two streaming services that are the go-to's in your house because in my house it's netflix and max we've talked about netflix on the show but on today we're going to talk about warner brothers discovery so to kick things off what are the do you have like two streaming services that maybe you're never going to cancel well in my in my household it depends on who you ask so if you're asking me uh my my go-to streaming services that i would never cancel are youtube and max if you ask my kids it's also going to be youtube plus disney plus so i have two two girls who love to watch their disney movies uh and no one is going to take that away from them youtube is the common thread we're going to focus on warner brothers discovery we'll focus on one of your favorites

more subscribers are going to max it uh subscriber count stood at 111 million subscribers in the latest quarter that was a gain of 7 million quite a bit but this is a multi-headed media conglomerate with cable arms, with intellectual property, movies. So I'm going to go back to a conversation I had with Patrick Battilato, a business professor at the University of Texas Macomb School of Business, where he encouraged us to think about value drivers for a company.

So let's set the table there. What are the most important value drivers for Warner Brothers Discovery? Well, let me start by saying that Warner Brothers Discovery has many valuable assets, including household linear TV channels like animal planet cnn hgtv discovery i could go on they also have premium cable and direct-to-consumer streaming service hbo and we were just talking about max and all the subscribers they're gaining there and finally i would say also the film studio part of the business of

the namesake warner brothers uh obviously they have had recent big hits like barbie last year They also own the rights to DC Comics, Harry Potter franchises. They have an entertainment studio in Burbank, California, and a video gaming segment as well, believe it or not. All of this is to say this is a storage company with many segments and immensely valuable assets. So if we go back to the question about value drivers, Warner Brothers has to grow its direct-to-consumer business both domestically and internationally and be able to do so profitably. And number two, they have to produce enough cash flow from the linear TV business and from IP rights to pay down its debts and reinvest in the business for future growth. Obviously, whether that be in the studio business or in the TV business, direct-to-consumer technology, you know, streaming is actually pretty costly to a lot of companies. There are a lot of technology investments that need to be made in order to make the streaming as seamless as most consumers experience it.

And finally, I would say that Warner Brothers has to answer perhaps the $1 billion question in the media business, which is, should they get bigger or should they get leaner? As in, should Warner Brothers Discovery consolidate with other legacy media businesses like, let's say, Comcast Universal, or in fact, get leaner by spinning off underperforming assets like CNN in order to pay down debt and cut losses and kind of just focus on core assets? I think its CEO, David Zaslav, would welcome some consolidation there. And we're going to talk a little bit about valuation later. For you listening, I would encourage you to think, what is the value that you personally would put on just HBO Max and having the rights to DC Comics and the Harry Potter franchises? So just those. We'll set aside the rest of the business. What value would you put on those three things? I want to talk about leadership, mention David Zaslav. And there's something interesting going on with the leadership of Warner Brothers Discovery. And I think it's affecting some of the decisions you're seeing, particularly on movies coming out of there. Recently, they had like a very small release of a new Clint Eastwood movie, Juror No. 2, that he directed. And it's also completely shelved movies like Batgirl and one called Coyote vs. Acme, which is one I was looking forward to seeing. It was going to be like a courtroom drama where Wile E. Coyote is suing the Acme Corporation over defective products. Now, here's the connection to leadership. Warner Brothers Discovery now has a pay package that is partially but importantly tied to free cash flow targets. So cynically, one may think, hey, they're just taking some immediate tax write-offs

to get those free cash flow numbers up. Have you seen leadership teams incentivized on these numbers before, usually it's market cap tied to stock options. It seems unusual. No, you're right. It is unusual. And I have not come across other businesses with similar incentive structure. But that is not to say that structure does not exist elsewhere. I just have not come across it. You know, the incentives in this case are for management to improve the balance sheet health of the business. This is a business, you know, let's remember that when Warner Brothers merged with Discovery Communications over two years ago, the combined entity had a debt load of over $55 billion. It was a massive debt load. The balance sheet was

highly, highly stressed. And I think the rationale, let's say, from the board when they created that incentive structure for the CEO, David Zaslav, was that they needed to produce as much cash flow as possible in order to pay down the debt as fast as possible. And David Dasloff has in fact been doing that. He has paid down over $10 billion, I think maybe over $12 billion of debt over the past couple of years or so. They have almost halved the net debt to EBITDA ratio. So the business is not as levered as it used to be. Again, this should be a good sign for many investors who think that in order for the stock to actually perform, they're going to need to get their balance sheets in a more balanced place. And that seems to be exactly where they're headed. So

I think that, yes, the shelving of movies is probably an unpopular decision for any executive to make, especially in the entertainment industry, where there are a lot of, you know, actors unions, writers unions and directors unions and so on involved and they hate to see this kind of thing but ultimately he has to make the decision that's going to be best for the business well he's prioritizing shareholders which you like to see ceos go for shareholder prioritization if you're owning the stock but there may be some long-term issues especially when you're encouraging folks like christopher nolan to walk out the door and go work with a company like universal maybe not being that bastion for those really high-level directors that Warner Brothers once was.

The market also is not... So it's this sort of two-sided storm. I just mentioned the filmmakers and also the shareholders that David Zaslav is trying to please. These investors are not so confident in Warner Brothers Discovery's ability to generate more cash. The stock price right now is at a three times free cash flow target. That's a heck of a lot lower than a company like Netflix. and also what I mentioned earlier, what is the value that you, the listener, would put on these three things? Harry Potter, the DC Universe rights, and also HBO, the Harry Potter rights, excuse me. The market cap of Warner Brothers Discovery is $22 billion, $23 billion. So what is the market here so sour about giving that stock a 3x times free cash flow

price tag? All right. So let's keep one thing in mind. In addition to the balance sheets situation that i i spoke about warner brothers has been stumbling from one crisis to another pretty much since that merger has taken place it started with the writers strike that was joined by an actor strike it also you know we also saw the them losing the rights to the nba a few months ago so there has been a lot of question marks there have been a lot of question marks about the business, about its ability to generate cash flow. We have continued to see lower cable subscribers, lower numbers for cable subscribers. People are cutting the cord. They're cutting the cable. They're moving to streaming. And let's keep in mind the streaming business is not actually

that profitable for a company like Warner Brothers. They would much rather everybody watch their stuff on linear TV. Having said that, they have been able to raise prices on the streaming business introduce ads and not lose subscribers in fact grow subscribers as they are doing so so all of these are good signs now the challenge if we were kind of to to you know to look at the big picture here the challenge that warner brothers has faced is threefold number one there is a secular shift away from you know that lucrative cable business i was just talking about to the less profitable streaming business number two big tech companies like an alphabet or amazon or apple are not only aggressively investing in their own streaming services but they're also

outbidding you know traditional uh entertainment companies like warner brothers for sports rights like i said the nba they lost it and you know social media is also disrupting the viewing habits of younger generations away from traditional tv i was just saying that youtube is a common thread for our household. People want to watch shorter videos, you know, up to the point and extremely niche interests that they have. So all of that is really kind of chipping away at that legacy media business model. And finally, the merger of Warner Brothers and Discovery has left the company with a lot of debt that they have had to pay. So all of this is to say the market is still skeptical that this is, you know, a healthy business that's going to grow into the

future, and that there are still unresolved questions about how legacy media in general, not just Warner Brothers Discovery, are going to be able to successfully navigate these challenges. And those cable assets, highly profitable, but Warner Brothers Discovery recently wrote down them by about $9 billion. Again, that market cap, $23 billion. That's a big chunk of change. You are a contrarian investor, and you like to look for places where other people are doubting. So, you know, this is one of those where it could be a cigar on the side of a road. Sometimes there's a few puffs in it. Sometimes you get a cold sore because you never know who was using that cigar before you.

So I'll ask you, is Warner Brothers Discovery, is it looking more like a value play or a value trap at this time to you? So I'm going to disclose that I do own shares of Warner Brothers Discovery and I've done so for over a year or so, as far as I can recall. Yes, I do take the contrarian bet on this company. I think that, you know, I view it more as a value play than a value trap. I think that David Zaslav has enough credibility from his tenure at Discovery Communication and the way he has managed the balance sheet so far to keep this business going and hopefully one day thrive, as I believe it should. I just think the assets are too valuable to be so heavily discounted.

And I can see Warner Brothers Discovery, and I definitely do not invest on the basis of hopeful acquisition. But I do see that there is a floor somewhere here. And that floor is that Warner Brothers just has so many valuable assets that it can become a prized acquisition for companies with media ambitions like an Apple or an Amazon. But, you know, again, this is definitely going to be on the more speculative side of my portfolio. Yasser Alshami, thank you for your time and your insight. I'm going to be taking another look at Warner Brothers Discovery after this discussion. Wonderful. Great to be here.

As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and are not approved by advertisers. TMF only picks products that it would personally recommend to friends like you. I'm Mary Long. Thanks for listening.

We'll see you tomorrow. We'll be right back.