Finman Case Study.docx

TARGET CORPORATION: Time for a Financial Health Check

A Case Study Presented to Ms. Janine Abu College of Business Economics, Accountancy and Management De La Salle Lipa

In Partial Fulfillment of the Requirements for Financial Management 2 Final Term, School Year 2018

by Arrianne Zeanna R. Dimaapi

December 24, 2018

INTRODUCTION As a business grows and matures, it will need more cash to finance its growth. Proper management of an organization’s finance provides quality fuel and regular service to ensure efficient functioning. Owners and business managers have the most important responsibility which is considering the potential consequences of their management decisions on profits, cash flow and on the financial condition of the company. The activities of every aspect of a business have an impact on the company's financial performance and must be evaluated and controlled. Target Corporation or simply known as Target is the second-largest retail store chain in the United States today. Target is known for its famous logo of a red bull’s eye. The brand has been in the business since more than a century and has come a long way to maintaining and providing their customers with a range of quality products – from everyday commodities and grocery offerings to trend-right home and apparel lines at significantly discounted rates. Target is currently led by the CEO and Chairman, Brian Cornell. Target continually reinvents its stores, including layout, presentation, and merchandise assortment, to create an engaging shopping experience.

History of the Company Target Corporation has a long and impressive history. Its track record is characterized by strong and relatively consistent growth as the firm has evolved from a small enterprise to a multi-billion dollar concern. Target’s roots trace back to the early 1900s when George Dayton opened a dry goods store in downtown Minneapolis. The firm was named Dayton Company for much of its early history, and the Target store concept was launched by Dayton in the early 1960s. Both Dayton and Target expanded to markets outside of Minnesota during the 20th century, and Dayton completed its IPO in 1967 where the firm was still managed by George Dayton’s descendants. After being managed in a fairly conservative manner for several generations, Dayton began to pursue a more aggressive growth strategy, supported by both internal investment and M&A. Significant acquisitions included Detroit-based J.L. Hudson & Company (1969), and California-based Mervyn’s (1978). The organization eventually renamed itself Dayton-Hudson, but Target stores had become the firm’s largest sales contributor by 1975. By the early 1980s, the Dayton family had become less involved in the organization’s day-to-day management, but company expansion efforts continued, further driven by the

acquisition of Marshall Field’s in 1990 which is a well-known Chicago-based retailer. By the early 1990s, the Target concept had established a national presence. The 1990s was a very eventful decade for Target, a period that included the launch of its superstore concept, the launch of its credit card, and the creation of the “Expect More. Pay Less.” brand identity. Dayton-Hudson was ultimately renamed Target Corporation in 2000, reflecting the increasing prominence of the Target concept within the organization. As of January 28, 2017, the Company had 1,802 stores across the United States, including 1,535 owned stores, 107 leased stores and 160 owned buildings on leased land (Reuters, 2018). Vision Guided commitments to great value, the community, diversity and the environment. Mission To make Target the preferred shopping destination for our guests by delivering outstanding value, continuous innovation and an exceptional guest experience by consistently fulfilling our “Expect More. Pay Less.” brand promise.

STATEMENT OF THE PROBLEM A large company such as Target gives off an appearance of a strong and reliable investment which may attract investors who are conscious of risks. But, the key to a company’s continuous success lies in its financial health (Brown, 2018). According to a news article in Yahoo! Finance (Smith, 2018), with current liabilities at $12,707.0M, Target is not able to meet their short-term obligations given the level of current assets of $11,990.0M. This could pose as a problem for the company because this would result to a negative working capital and if such situation continues, it could result to liquidity problems – it may have trouble paying back creditors or serious financial trouble. It is also indicated that the company is holding a high level of debt relative to its net worth.

DISCUSSION AND ANALYSIS In relation to Financial Management, working capital can affect a company's longer-term investment effectiveness and its financial strength in covering short-term liabilities. Working

capital represents what a company currently has to finance its immediate operational needs, such as obligations to its vendors for extending credit on purchases of various goods and services to be used in the production process, inventory, cash balance and accounts receivable. In Target’s situation, there is an increase in risk since it cannot pay its obligations as they become due. If working capital is negative temporarily, it normally indicates that the company may have incurred a large cash outlay or a substantial increase in its accounts payable as a result of a large purchase of products and services from its vendors. However, if the working capital is negative for an extended period of time, it may be a cause of concern for certain types of companies, indicating that they are struggling to make ends meet and have to rely on borrowing or stock issuances to finance their working capital. But if the company could have a more predictable cash inflow, the less net working capital it would need. The conversion of current assets from inventory to receivables to cash provides the source of cash to pay the current liabilities. To recall cash conversion cycle (CCC), it is the length of time required for a company to convert cash invested in its operations to cash received as a result of its operations. In order to compute for CCC, we subtract the average payment period (APP) from the sum of the average age of inventory (AAI) and the average collection period (ACP). Using the data obtained which is of the same date as the when the article was published, Target Corporation’s CCC is computed as follows: Cash Conversion Cycle = ACP + AAI - APP =

0

+ 60.56 - 61.95

= -1.39 Where (in millions): ACP = Accounts Receivable / Sales x Days in Period =

0

=

0.00

/ 71879 x

365

AAI = Average Inventory / Cost of Goods Sold x Days in Period =

8483

=

60.56 days

/

51125

x

365

APP = Accounts Payable / Cost of Goods Sold x Days in Period =

8677

=

61.95 days

/

51125

x

365

Based on the results, Target has a negative cash conversion cycle which means that the company needs less time to sell its inventory and receive cash from its customers compared to time in which it has to pay its suppliers of the inventory or raw materials. This result is obtained because there is no accounts receivable for that period, meaning the company does not have to wait for receivables to be paid for. Also, payables are viewed as a source of operating cash or working capital for the company. Thus, the company’s cash conversion provides the source of cash it needs to pay its current liabilities. Target Corporation is referred to as a highly levered company given that it has more debt than equity. In order to determine if Target’s debt levels are sustainable, the management could measure interest payments against earnings of the company. According to Brown (2018), it is preferable that earnings before interest and tax (EBIT) should be at least three times as large as net interest. EBIT is computed as follows (millions, except per share data): Sales Revenue Less: Cost of Goods Sold Gross Profit Less: Operating expenses Earnings before interest and taxes (EBIT)

$ 71,879 51,125 20,754 16,442 $ 4,312

EBIT / Net Interest = $ 4,312 / $ 666 = 6.47 Target Corporation has a ratio of 6.47 suggests that interest is well-covered. This determines how easily a company can pay their interest expenses on outstanding debt. High interest coverage is seen as a responsible and safe practice because it lowers the company’s debt burden, which highlights why most investors believe highly levered company such as Target is a safe investment.

CONCLUSION Working capital should be paid attention to as it is the funds available to the company for use in its day-to-day operations. It reflects how a company is being managed. The amount of a company's working capital changes over time as a result of different operational situations. Thus, working capital can serve as an indicator of how a company is operating. When there is too much working capital, more funds are tied up in daily operations, signaling the company is

being too conservative with its finances. Conversely, when there is too little working capital, less money is devoted to daily operations which serve as a warning sign that the company is being too aggressive with its finances. CCC is most effective with retail-type companies, which have inventories that are sold to customers. The CCC is one of the tools that can help companies evaluate management, especially if it is calculated for several consecutive time periods and for several competitors. Generally, the lower CCC, the better it is for the company. Decreasing or steady CCCs are good, while rising ones should motivate company’s management to dig a bit deeper. Despite the fact that Target is a high leverage company, it still has the ability to pay back all the interests incurred from borrowing debt, which is a reason why the company is treated as a safe investment. Being able to identify the ratio of EBIT to interest expense of the same period is essential to survive any financial hardships in the future.

RECOMMENDATION In general, Target Corporation is not generating sufficient resources to cover its short term liabilities. The company should not rely excessively on cash flow provided by operations and short-term borrowings. If there are disruptions in the financial markets or the company is unable to obtain bank credit, it could easily reduce the company’s ability to meet its capital requirements or fund its working capital needs, which could adversely affect its financial position and results of operations. Proper management of working capital is essential to a company’s fundamental financial health and operational success as a business. Effective inventory management is also a key to Target’s success. There should be a careful planning of inventory levels to minimize markdown since the company’s operation also depends on successfully maintaining a certain level of inventory to meet the demand of core products and a high level of inventory poses a threat to the company’s ability of covering its short term liabilities. The company should also consider short-term management practices to effectively manage its current assets and liabilities and to achieve a balance between profitability and risk that contributes positively to overall firm value.

REFERENCES Boyar's Intrinsic Value Research LLC (2014). Target Corporation, Volume XL, Issue III. Retrieved

from

http://www.boyarresearch.com/case-

studies/TGT%20March%202014.pdf Brown, D. (2018). Target Corporation (NYSE:TGT): Time For A Financial Health Check. Retrieved from https://simplywall.st/stocks/us/retail/nyse-tgt/target/news/targetcorporation-nysetgt-time-for-a-financial-health-check/ Hawley, J. (2018). Why working capital management matters. Retrieved from https://www.investopedia.com/ask/answers/100715/why-working-capitalmanagement-important-company.asp Smith, M. (2018). Does Target Corporation’s (NYSE:TGT) Debt Level Pose A Problem? Retrieved from https://finance.yahoo.com/news/does-target-corporation-nyse-tgt154308918.html Target Corporation (n.d). Target Corporation’s History Throughout the Years. Retrieved from https://corporate.target.com/about/history Target Corporation (2018). Target Reports Fourth Quarter and Full-Year 2017 Earnings. Retrieved http://investors.target.com/phoenix.zhtml%3Fc%3D65828%26p%3DirolnewsArticle%26ID%3D2336390

from