Capitalizing on Target’s Future

Target Corporation (NYSE: TGT) shares dropped sharply over the past month as concerns about the economy weighed on the retail sector. Consumer spending has fallen sharply going into a holiday season that is expected to be the worst in more than 20 years. However, many experts believe that the sharp decline in retailers is overdone while at least one activist investor presented a plan designed to unlock substantial value in the retailer.

William Ackman unveiled a plan last month designed to unlock value in Target’s real estate assets. The activist investor believes that the land beneath Target stores is worth around $40 billion with an additional $20 billion of unencumbered buildings. As a result, the investor recommended that the firm spin-off its land assets into an REIT that would then lease-back the land to Target. The transaction would result in an estimated $70 per share in value with substantial upside going forward.

Target’s critics point to their credit card portfolio as a cause for concern, however. The retailer sold approximately half of its receivables to J.P. Morgan for $3.6 billion in a deal last year that was supposed to mark the beginning of a long-term relationship. Unfortunately, the turbulant credit markets since the deal was inked has caused concern that the remaining half of the portfolio may have lost its value. Target bulls, however, insist that these concerns are overstated.

Income from Target’s credit card portfolio accounted for 3.3% of total sales last quarter with net charge-offs expected to rise to 9% of its receivables for the full year. Despite these rising delinquency rates, the segment still showed earnings of $74 million during the last quarter. In fact, bad debt expense could rise another 28% before the segments profitability would be diminished. The retailer is also taking action to curb rising deliquencies by tightening its standards on new and inactive card holders. These trends are not good for Target as it raises its loan loss reserves to catch up to delinquency rates, but many experts suggest that the charges won’t affect earnings as much as some investors fear. 

Investors interested in taking advantage of a retail turnaround over the next couple of years, combined with the possiblities of value being unlocked at Target, may want to consider long-term options called LEAPS. Currently, the $35 January 2011 calls are trading for just $10.85. This puts the breakeven point to $45.85 per share with the initial position costing just $1,085 to setup for the rights to buy 100 shares at $35 per share between now and January 2011.

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