blade5adj (< 20)

The Credit Crunch that Stole Christmas: Taking Down Target (NYSE: TGT)

November 13, 2008 – Comments (2) | RELATED TICKERS: TGT , WMT , SCC

(to view this post in its original format, click here)

If you were working at Circuit City, chances are you knew that something was going to happen when Blockbuster announced it had made an unsolicited $1 billion bid for the company in mid April 2008.  That still probably didn´t help soften the blow when the company declared bankruptcy on Monday.  Today the company announced that Bank of America would be providing a $1.1 billion credit line for the company, which Bloomberg cited Circuit City as saying would ¨…help pay for its emergence from bankruptcy next year¨.  But this brings up the larger thematic issue: is this an isolated event or the telling of more events to come?

One sign that it might be a foreboding signal is the date of the bankruptcy filling: before Thanksgiving and way before Christmas.  Like most consumer discretionary companies, Circuit City makes a large chunk of their money during the Christmas season, when Americans hoping to impress spouses and win back the love of their children buy gifts and generally ramp up consumption.  Although consumer spending is not expected to be stellar this Christmas season, Circuit City wasn´t around long enough to see if that would be the case.  One would expect that they would have held off announcing bankruptcy until after they found out that this holiday season was going to result in crummy spending.  The fact that they announced it before means that they really didn´t have anything left to make the long haul.

So what do you do if you´re looking at your portfolio and trying to spot consumer discretionary bad apples, or are looking for some trades to maybe turn a couple bucks?  Well, here´s some advice to help.

What To Look For in Companies That Might Get Burned

Looking in to the reasons provided for Circuit City´s bankruptcy filing can be pretty telling in trying to find similar situations.  The company cited a lot of payables owed to a host of companies ranging from Hewlett Packard to Samsung, and a market that was becoming progressively more competitive with  increasingly more internet shopping and the fat bed mates of Best Buy and Wal-Mart.  Put it together, and it makes sense why Circuit City didn´t see a point to keep on going.

Although you could easily use this strategy to pick through other consumer discretionary companies and find the bad apples, if you were trying to go for that, the time was a month ago, as this bankruptcy filing likely threw the short sellers in consumer stocks in to overdrive looking for potential look-alikes.  Because of this, I think you might be in line for better gains if you look at something that the credit crunch has a lot more to due with: credit card receivables.

Target Might As Well Just Paint a…Oh Wait, They Already Did

If you´re looking for a company that might be a spectacular fall from grace story, look no farther than Target Corp. (NYSE: TGT).  Although the company is already sitting at a little more than half of their 52-week high, you could say the same thing about most of the S&P 500.  But short selling is all about percentages, and if something really bad happened with this titan you´d probably make today´s price look like a joke.

You may or may not remember, but a while back Target was trying to find a purchaser for their credit card division, which on their most recent 10-Q they stated as being worth a whopping $7.98 billion, 43% percent of their total assets.  Money from credit cards accounted for 3.2% of total revenues for last quarter, and a pretty hefty 12.6% of their before taxes profit.  Looking a little bit further, we see that ¨Nonrecourse debt collateralized by credit card receivables¨ accounts for $5.47 billion of their total liabilities, or 27%.  With all this, we can see that this is a company that relies pretty heavily on credit cards.

It was tossed around back in March 2008 that Target might get as little as half for their receivables from a potential bidder, and now that number is likely significantly less.  For a company that is projected to earn $9.28 billion next quarter, a write off like that would provide a significant pounding to their share price.  Regardless of whether or not they sell it, we might see earning go down as those profits related to credit cards get chopped away.  Anyway you look at it, Target is facing some significant risk this holiday season.

What Else You Can Do

If you wanted to go the easy way to reducing your exposure to a bad holiday season, you could pick up an ETF like ProShares UltraShort Consumer Services (NYSE: SCC).  The only problem with this short ETF is that 11.20% of the index it performs inverse to is invested in Wal-Mart (NYSE: WMT).  I say this because they´re probably the only company waxing optimistic on this holiday season, and that coming off their ¨9.8 percent gain in third-quarter profit, beating analysts’ estimates¨ makes them probably the most likely to outperform out of the whole bunch.  That doesn´t bode well for the ultrashort, so because of this I would look at individual companies.

If you´re looking for other ways to protect yourself, you could look at my article ¨Dollar Bear or Dollar Bull: Trying to Get on the Right Side of the Guillotine¨, which takes a look at cash, treasury bills and gold to see which one is likely to do the best for you and provide you with the most liquidity.