Target (TGT) Ratings Reaffirmed by S&P Amid Exit from Canadian Market

Standard & Poor’s Ratings Services today affirmed all ratings on the Minneapolis-based Target Corp. (NYSE: TGT), including the 'A' corporate credit rating. The outlook is stable.

"The affirmation comes after Target announced that it is exiting its Canadian business through a Companies’ Creditors Arrangement Act (CCAA) filing. The action will effectively allow Target to wind down its Canadian business and more efficiently sell its leasehold interests," said credit analyst Charles Pinson-Rose. "The company will incur substantial impairment charges associated with the large investment made in the market. However, we expect the cash payments associated with exiting the business are roughly commensurate with expected operating losses. Thus, the exit should be cash flow neutral and accretive to profits."

The stable rating outlook on Target reflects our expectation that the company will achieve stable or slight increases in same-store sales over the near term, and that the gross margin trend should mostly stabilize by the fourth quarter (as the company has relatively easy comparisons in that regard). We also believe there will not be meaningful legacy liabilities associated with the Canadian exit and that the cash cost to exit the business are roughly commensurate with recent annual operating losses in the business. Once the company anniversaries the one-time charges, we expect adjusted EBITDA to be near 2.0x.

Downside Scenario

We could lower the rating if Target's financial policy becomes more aggressive than we currently expect and it undertakes sizable debt-financed share repurchases or if the operations deteriorate, leading to leverage in the mid-2x area on a sustained basis. We estimate this could occur if EBITDA meetsour forecast and the company issues debt to repurchase more than $3.5 billion and uses its excess cash for share repurchases.

We note that Target has recently halted share repurchases to preserve credit ratios and is now generating excess cash. Given Target's ability to generate cash, we estimate the company could absorb EBITDA declines in the high-single-digit ranges and still maintain credit ratios for the current rating—as it has done—as long as the company allocates capital to improve leverage rather than return it to shareholders.

We expect the profit performance to stabilize, but if the company's profit trends (high-single-digit EBITDA declines for example) are weak in the fourth quarter and such a trend persists into the upcoming fiscal year, a lower rating is possible as we would likely revise our comparable ratings analysis to "neutral" from "positive", which would drive a one-notch downgrade.

Upside Scenario

Although unlikely over the next year, an upgrade could occur if the company pursues a financial policy, in combination with improvement in its core U.S. operations, such that earnings improve and leverage strengthens to below 1.5x on a continued basis. In this situation, we would also want to be confident that the company would have stable operating trends.

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