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Bullish Optimism for Target Is Way Off the Mark

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In fact, it may be time to short the stock.

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Investors and economists had hoped and predicted that consumer spending would bounce back strongly this spring and summer following this past winter's deep freeze. But recent reports suggest it is in hibernation. 

This has been reflected in the underperformance of the retail sector as measured by the SPDR Retail ETF (NYSEARCA:XRT), which is down 5.5% year to date compared to a 7% gain for the S&P 500 Index (INDEXSP:.INX)

The damage has been widespread; in the past few weeks companies ranging from Michael Kors (NYSE:KORS), Family Dollar (NYSE:FDO), and Gap (NYSE:GPS) all saw their shares tumble after issuing disappointing news. Shares of The Container Store (NYSE:TCS) sunk some 20% after it missed earnings with the CEO claiming the "consumer is in a funk."

Wal-Mart (NYSE:WMT) warned that despite an increase in employment, sales will be below expectations and might take months to pick up. Others such as Ross Stores (NASDAQ:ROST) and TJ Maxx (NYSE:TJX) are down double digits and hitting 52-week lows on analyst downgrades.  

It is against this backdrop that shares of Target (NYSE:TGT) have somehow climbed 11% to $60, a two-month high. Granted the stock is still off 4% year-to-date, but this recent increase suggests investors are anticipating a marked improvement from the big-box retailer. 

The recent rally is premised on hopes for a turnaround. This bullish optimism is off the mark. I think the stock, currently around $60 per share, is a good short candidate. 

In addition to the macro headwinds of sluggish consumer spending evidenced above, Target faces several company-specific challenges. 

Target, along with many other retailers, no longer provides monthly same-store sales numbers, but given that three of the last four quarters have seen a year-over-year decline in earnings per share, the trend is not good.  

The shift to online shopping and the competitive threat Amazon (NASDAQ:AMZN) poses will continue steal market share. Digital accounts for only 2.5% of sales. Management has stated it plans to become a leading "omni-channel" retailer, but so far it has done little except toss around such buzzwords and make promises to provide the customer with great products and experience. 

It did manage to increase website visits by 20% during the first quarter, but online sales only increased 4%. Given the low base, that's not moving the needle much. 

The company is still contending with winning back consumer trust after the credit card-hacking debacle. Target has said it is accelerating the rollout of secure chip cards but it is taking longer than anticipated. This remains a huge cloud hanging over the company from both an operational and managerial standpoint. 

Target's expansion into Canada continues to be a very disappointing drag and distraction. The company opened too many stores at once without proper market research. Sales were dismal to the point the company created a video apologizing to customers and promising to do better. It's painful to watch. 

Target has simply lost its cachet as an inexpensive place for somewhat hip products. Target pioneered the concept of getting high-end designers to create mainstream lines for its stores. When it had names such Isaac Mizrahi's in its stable Target, jokingly pronounced with a French accent, was a shopping destination. Now its merchandise is just viewed as merely serviceable.

Offering groceries has not helped drive traffic like it has for Wal-Mart. It will likely have to become more promotional. It is already offering back-to-school sales. This will likely pinch margins.

For a potential turnaround story, the stock is not cheap. It now trades around 20x current and 13x next year's earnings. That's not only above Wal-Mart, but also richer than TJ Maxx, which has genuine growth prospects.  

Management has its hands full and a long road to walk before the company can claim to get back to its glory days. It's just as possible Target heads down the paths Sears (NASDAQ:SHLD) and JC Penney (NYSE:JCP) have traveled. I'm entering a limit order to buy puts.

With the stock pushing up against a long-term downtrend line at the $60 level, I'm buying the January $55 puts at 1.30 a contract. I expect the shares to slip to new lows this fall. 

Twitter: @steve13smith

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No positions in stocks mentioned.

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