NEW YORK — While Target Corp. continues to stand behind its Mervyn’s moderate department store division, Wall Street has questioned the wisdom of retaining a business whose deteriorating operating results are increasingly pressuring the parent’s bottom line and stock valuation.
“Weakness at Mervyn’s has likely been an important factor in the company missing earnings expectations in three of the last four quarters,” wrote Emme Kozloff, an analyst at Bernstein Research, in a report published last week.
Mervyn’s annual comparable-store sales have been pulling down the corporate average, most recently having fallen 5.3 percent in 2002 and 1.5 percent in 2001. The analyst’s 2003 comp-store forecast anticipates a decline of 8.2 percent.
Mervyn’s also continues to fall short of Target’s goals. For the third quarter ended Nov. 1, Mervyn’s reported a 41.8 percent plunge in pretax earnings to $31 million on a 10.1 percent drop in sales to $825 million and an 11.1 percent decline in comps. The below-plan results at Mervyn’s, as well as a disappointing showing by corporate sibling Marshall Field’s, led chief executive officer Robert Ulrich to warn investors on a conference call that Target is “likely to fall modestly short” of Wall Street’s fourth-quarter consensus estimate of 90 cents. Wall Street has since scaled back its outlook to 87 cents.
“In general, we estimate that a 2 percentage point shortfall in Mervyn’s comparable-store sales growth impacts earnings per share by about a penny,” wrote Kozloff.
Despite Mervyn’s mounting troubles, Kozloff told investors not to bet on the chain leaving the Target family anytime soon.
“We believe from speaking to industry contacts that the likelihood of a strategic buyer making an offer for Mervyn’s is slim, at any price,” wrote Kozloff.
That leaves liquidation as the only alternative, and by Kozloff’s measure, Mervyn’s is simply worth more to its corporate parent alive than dead. As Kozloff said, “If the present value of the cash flows generated by the business is greater than the value that can be obtained by liquidating — and selling the assets — then it makes more financial sense to continue to operate the business.”
Though Kozloff admits that is a relatively simplistic way of analyzing the situation, it makes for a powerful argument. After taking into account a number of factors, including the value of Mervyn’s owned property and inventory liquidation, Kozloff estimates that liquidating Mervyn’s would generate a cash flow value of $1.15 billion. By comparison, the current discounted cash flow value of the Mervyn’s business as a going concern is $1.26 billion.
“We believe that in order for liquidation to become attractive for management,” wrote Kozloff, “Mervyn’s would have to continue to post comp-store sales in the negative mid- to high-single digit range and deteriorating operating margins, essentially contracting the division’s free cash flows by 20 to 30 percent, which would lower the net present value below the level of the liquidation proceeds.”
Complicating the scenario, Target’s discount operations also benefit from relationships the midtier department store maintains with vendors. Ulrich has said in the past that the firm is committed to Mervyn’s, as well as the underperforming Marshall Field’s division, partly because they add value through scale and in cross-sharing of merchandise ideas.