Target Misses the Mark

In this podcast, Motley Fool analyst Jason Moser and host Mary Long discuss earnings from Target and The TJX Companies, 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 guidance.

Then, Motley Fool analyst Yasser el-Shimy and host Ricky Mulvey take a look at Warner Brothers Discovery and debate whether the streaming stock is a steal.

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This video was recorded on Nov. 20, 2024.

Mary Long: We got another look at the American consumer, Motley Fool Money starts now. I’m Mary Long, joined today by Jason Moser. Jamo, lovely to see you. How you doing?

Jason Moser: Always happy to be here. I’m doing great. How are you, Mary?

Mary Long: 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.

Jason Moser: Good.

Mary Long: 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 interesting to me to see how different retailers stack up, whereas Walmart earnings yesterday were strong. Target showed lower sales, lower profit, 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 court challenging operating environment. What do you mean by that? Why doesn’t Walmart seem to have been affected by the same environment?

Jason Moser: Yeah. I mean, this does seem like something we’ve heard a lot over the last several quarters, the challenged consumer. I think that’s really what most of this is all about, is just consumers continue to spend very cautiously. I think most notably in discretionary categories. Unfortunately, for Target, that’s a place where they need to shine. He did refer in the call to consumer behavior being somewhat cautious. Remember the dock workers strike, we talked about that several weeks back. 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 and management saw that, and they thought, OK, let’s try to prepare for the worst and then hope for the best. They pulled in a lot of inventory to prepare for potential shortages. 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. They don’t operate quite as efficiently when they’re so full. When he’s talking about being full, he’s talking about their inventory. 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. If you look at their inventory levels, inventory was up about 3% from a year ago. Certainly, it does make sense. They just tried to make sure they didn’t fall prey to that shortage issue that certainly could have happened if the dock workers 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 that forward guidance as well.

Mary Long: A big story with Target even a couple 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?

Jason Moser: No, I think he does. I think any CEO worth his or her soul knows that inventory in this game, when you’re talking about big box retailers, inventory is just one of the tougher parts of managing these businesses, and it ebbs and flows. It’s not just some constant line one way or the other. 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.

Mary Long: I want to zoom in on a couple of metrics that at least stuck out to me. Traffic within stores was up about 2.5%, but in store comp sales down about 2% for the quarter. 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?

Jason Moser: I definitely don’t think this is just a Target specific issue. You noted a good point there. Traffic was up, however, comps down and if we look at tickets, there was a 2% decline in average ticket. 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. He made this point time and time again. They know that there are deals out there. Consumers everywhere were all looking for deals. 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. That’s something that plays into not only a target, it plays into virtually every one of these retailers, and so it’s something that they’re going to have to deal with.

Mary Long: 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 trim expenses a bit, but that doesn’t seem to be what’s actually happening here.

Jason Moser: 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. Scale is the word here that comes into play. To me, you think of e-commerce giants in the space and the obvious one being Amazon. For so long, Amazon was just in the business of ultimately losing money, and everybody wondered. How in the world is Amazon garnering this valuation when they’re not making any money? 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. Think of companies like Chewy. Chewy, still working toward really getting that model toward 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. When we talk about these legacy brick and mortars, which target is one of those, it’s just a lot of work. I think they’re absolutely making the right call and doing it, but there will be some hiccups along the way, for sure.

Mary Long: It can 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 being chartered by Amazon and Walmart, these two big e-commerce players. On the other path, you’ve got the TJX stores, which we’re going to talk about more in a second, while they have online ordering, they really play more to this in-person treasure hunt style type approach. I see Target as straddling both of those styles and being in the middle. On the one hand, you could think that’s a massive opportunity for them. On the other hand, 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?

Jason Moser: 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. They shine in discretionary, and they also are taking advantage of the groceries space. We talk about companies like Walmart. 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. Target does also participate in that groceries segment. That I think is really important. I think for businesses like Target, and Walmart and others, the ultimate key they’re going to need to focus on that word Omnichannel.

We’ve heard that word many quarters over many, many years now. Home Depot, Target, Walmart they are focusing on being Omnichannel. I think for legacy brick and mortars, that’s been the real big pivot. Amazon, for example, didn’t really have to worry about the Omnichannel 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. 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 Omnichannel strategy.

Mary Long: 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. How exactly does management land on these forecasts, and what game are they playing in spelling that out for investors?

Jason Moser: It’s definitely an art form for sure, and I wouldn’t put them all in the same sandbox, so to speak I think, you’ve got some companies that prefer to sandbag. They want to set low expectations and then try to exceed those expectations. But ultimately, these companies they’re going with the data that they have at the moment. Management teams are just going with the data that they have at the time. It’s always worth remembering quarter in and quarter, you see things change. The dock workers 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 are trying to work out there. But it’s absolutely more of an art form when it comes to forward looking guidance. I think the best thing investors can do in regard to that is just paying attention to what these management teams say over the stretch of earnings seasons. 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 are 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 that quarter by quarter game that these teams play. It absolutely is worth remembering that not every company is the same in this regard.

Mary Long: I want to turn real quickly to another retailer, this one, TJX. That’s the parent company of TJ Maxx, Marshall’s, HomeGoods, Sierra, a number of retailers. They reported this morning as well, reported higher sales, higher net income, spoke about a strong start to the holiday shopping season. Yet, management lowered EPS guidance for the fourth quarter. 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?

Jason Moser: Well, and that’s interesting because it seems like they’re looking at the fourth quarter as perhaps a little bit more challenging. There are 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. We’re looking at fourth quarter versus the entire year. If we look back to just a quarter ago, they had called for earnings per share for the full year in the $4.09-4.13 range.

In this quarter, they actually bumped that up to $4.15-4.17. I think I wouldn’t worry so much about the nitpicking on the quarter. Again, TJ Maxx, TJX companies, they’re a company. They’re 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 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.

Mary Long: 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.

Jason Moser: Thank you.

Mary Long: While investors are optimistic about the future of Netflix, Warner Bros. Discovery, the owner of Max and HBO, is in the bargain bin. My colleague Ricky Mabe caught up with Fool Senior Analyst Yasser El-Shimy to talk about the value drivers for Warner Bros. Discovery, and if the stock is cheap for good reasons.

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Ricky Mulvey: Yasser, do you have two streaming services that are the go tos in your house? Because in my house, it’s Netflix and Max. We’ve talked about Netflix on the show, but today we’re going to talk about Warner Bros. Discovery. To kick things off, what do you have like two streaming services that maybe you’re never going to cancel?

Yasser El-Shimy: In my household, it depends on who you ask. 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+. I have two girls who love to watch their Disney movies, and no one is going to take that away from them.

Ricky Mulvey: YouTube is the common thread. We’re going to focus on Warner Bros. Discovery. We’ll focus on one of your favorites. More subscribers are going to Max. Subscriber account stood at 111 million subscribers in the latest quarter. That was a gain of seven million quite a bit. But this is a multi-headed media conglomerate with cable arms, with intellectual property, movies. I’m going to go back to a conversation I had with Patrick Badolato, a Business Professor at the University of Texas McComb School of Business, where he encouraged us to think about value drivers for a company. Let’s set the table there. What are the most important value drivers for Warner Bros. Discovery?

Yasser El-Shimy: Let me start by saying that Warner Bros. Discovery has many valuable assets, including Household Linear TV Channels like Animal Planet, CNN, HGTV, Discovery, Echo 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. Finally, I would say, also the film studio part of the business of the namesake Warner Bros. Obviously, they 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 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. If we go back to the question about value drivers, Warner Bros.

has to grow its direct to consumer business both domestically, and internationally and be able to do so profitably. Number 2, 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, 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. Finally, I would say that Warner Bros has to answer the perhaps a one billion dollars question in the media business, which is, should they get bigger or should they get leaner? As in, should Warner Bros. 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 just focus on core assets.

Ricky Mulvey: I think it’s CEO David Zaslav would welcome some consolidation there. 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? 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 Zaslav and there’s something interesting going on with the leadership of Warner Bros. Discovery, and I think it’s affecting some of the decisions you’re seeing, particularly on movies coming out of there. Recently, they had a very small release of a new Clint Eastwood movie, Juror Number 2 that he directed. 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 courtroom drama where Wiley Coyote is suing the Acme corporation over defective products.

Now, here’s the connection to leaders. Warner Bros. Discovery now has a pay package that is partially but importantly tied to free cash flow targets. 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 incentive on these numbers before? Usually, it’s market cap tied to stock options. It seems unusual.

Yasser El-Shimy: Now 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. The incentives in this case are for management to improve the balance sheet health of the business. This is a business. Let’s remember that when Warner Bros. 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 stressed. 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. David Zaslav 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 EBIDA ratio. 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 are going to need to get their balance sheet in a more balanced place and that seems to be exactly where they’re headed. 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 actors unions, writers unions, and director unions and so on, involved and they hate to see this thing. But ultimately, he has to make the decision that’s going to be best for business.

Ricky Mulvey: He’s prioritizing shareholders, would 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 Bros. once was. The market also it’s this 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 Bros. Discoveries 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 the Harry Potter Rights. The market cap of Warner Bros. Discovery is $23 billion. What is the market here so sour about giving that stock a 3X times free cash flow price tag?

Yasser El-Shimy: Let’s keep one thing in mind. In addition to the balance sheets situation that I spoke about, Warner Bros. 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 actors strike. We also saw them losing the rights to the NBA a few months ago. 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. 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. All of these are good signs. Now, look at the big picture here. The challenge that Warner Bros. has faced is threefold. Number 1, there is a secular shift away from that lucrative cable business are just talking about to the less profitable streaming business.

Number 2, 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 traditional entertainment companies like Warner Bros. for sports rights. Like I said, the NBA, they lost it. 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 up to the point and extremely niche interests that they have. All of that is really chipping away at that legacy media business model. Finally, the merger of Warner Bros. Discovery has left the company with a lot of debt that they have had to pay. 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 Bros. Discovery are going to be able to successfully navigate these challenges.

Ricky Mulvey: Those cable assets, highly profitable, but Warner Bros. 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 places where other people are doubting. 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. I’ll ask you, is Warner Bros. Discovery? Is it looking more like a value play or a value trap at this time to you?

Yasser El-Shimy: I’m going to disclose that I do own shares of Warner Bros. 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, I view it more as a value plate 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 Bros. 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 Bros. 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 again, this is definitely going to be on the more speculative side of my PTCOL.

Ricky Mulvey: Yes. Yasser El-Shimy thank you for your time and insight. I’m going to be taking another look at Warner Bros. Discovery after this discussion.

Yasser El-Shimy: Wonderful. Great to be here.

Mary Long: 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. Buyers 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.