Motley Fool Money - 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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We got another look at the American consumer. Motleyful money starts now. I'm Mary Long, joined today by Jason Moser. J-Mo, lovely to see ya. How 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 am 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 percent 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 it 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 regard 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 potentially. 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 just, 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, an 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 in perhaps, you know, that forward guys. 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 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, one of the tougher parts of managing these businesses. And it ebbs and

flows, right? It's not, it's not just some sort of constant line one way or the other. And so, 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 two and a half percent, 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.

an average ticket. So yes, people are spending less. And if we go back to, you know, 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, insour 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 targets 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 the 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, 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. 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 they, 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, okay, look at their stock this morning. It's down over 20% on the latest performance. Does Target have to pick one path over another? Or 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 shine in discretionary, and they also are taking advantage of the grocery space. We talk about companies like Walmart, I mean, one of Walmart's biggest advantages 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 and Walmart and others, the ultimate key is going to, they're going to need to focus on that word Omnichannel, right? And we've heard that word many, many, many quarters, 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 Omni Channel 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, they'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,

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. 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. 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 all, 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, T.J.X. That's the parent company of T.J. Max, Marshall's, Home Goods, 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, management lowered EPS guidance for the fourth quarter. So why is this? If the CEO can say, hey, the holiday shopping season is 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 $4.9 to $4.13 range. In this quarter, they actually bump that up to $4.15 to $4.17. So I think I wouldn't worry so much about the nitpicking on the quarter. Again, I mean, T.J. Max 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 some 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 said. 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 Mulby, caught up with full senior analyst Yasur al-Shimi to talk about the value drivers for Warren Brothers Discovery and if the stock is cheap for good reasons. What does leadership really look like? On the power of advice, a new podcast series from Capital Group,

you'll hear from athletes, entrepreneurs, and executives who've led on the field, in the boardroom, and in their communities. It's not about titles. It's about impact. Discover what drives them and the advice they carry forward. Subscribe and start listening today, published by Capital Client Group, Inc. So, Yasser, do you have like two streaming services that are the go-toes 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, 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. I have two girls who love to watch their Disney movies, 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. 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 let's set. I'm going to go back to a conversation I had with Patrick Battalado,

a business professor at the University of Texas McComb 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, you know, let me start by saying that Warner Brothers Discovery has many valuable assets, including, you know, 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. Obviously, they had had recent big hits like Barbie last year. They also owned the rights to DC Comics, Harry Potter franchises. They have an entertainment studio in Burbank, California, and a video gaming store. 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 consumer technology. You know, streaming is actually pretty costly to a lot of companies and 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 the perhaps a $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 Zaslov, 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, mentioned David Zazlov. 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 number two that he directed. And it's also completely shelved movies like Batgirl and one called Coyote versus Acme, which is one I was looking forward to seeing. It was going to be like a lot, like a courtroom drama where Wiley 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 rate-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 helps 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, you know, for the C.E. CEO, David Zaslov, 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 Datslough 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 Ibeda 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 Zazlov 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 it a three times free cash flow target. That's a heck of a lot lower than a company like Netflix. And also when I mentioned earlier, what is the value that you, the listener would put on these three things, Harry Potter, the DC Universe writes, 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 spoke about. Warner Brothers has been stumbling from one crisis to another, pretty much since that merger

had taken place. It started with the writer's strike that was joined by an actor's strike. It also, you know, we also sell 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 Bros. 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 are kind of to, you know, 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 a investing in their own streaming services, but they're also outbidding, you know, traditional 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 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 at places where other people are doubting. So, you know, this is one of those where it's the, 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. It's 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 viewed more as a value play than a value trap. I think that David Zaslov has enough credibility from his tenure in 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 it's, 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. on. But, you know, again, this is definitely going to be on the more speculative side of my portfolio. Yes, shall show me. 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 two friends like you. I'm Mary Long. Thanks for listening. We'll see you tomorrow.