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Target’s cash funded tender offer improves already strong credit metrics
admin | September 25, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Target Corporation (TGT) announced that it would be tendering for $1.75 billion of debt in a waterfall tender offer. The tender is primarily focusing on high coupon debt throughout the capital structure, a move seen from other high quality single-A credits such as The Coca-Cola Company (KO), given the current low rate environment. Target is using cash on hand to fund the tender, while similarly rated peers have funded their tender offers with newly issued debt. The offer, with an Early Tender Deadline of October 6, 2020, further strengthens an already strong balance sheet, underscoring that TGT is a core hold in the retail sector.
Management has largely maintained a very strong balance sheet and has been targeting high coupon debt for quite some time to improve interest costs and coverage metrics. A majority of the bonds in the tender offer have been tendered for in the past, as early as 2013. TGT’s EBITDA/interest coverage at the end of 2Q20 stood at 16.4x, over three turns better than higher rated peer Walmart (WMT).
Exhibit 1. TGT vs. WMT Credit Profile Comparison
Source: Company Reports; Amherst Pierpont Securities
Waterfall Tender
The waterfall tender is targeting ten series of bonds with a total principal outstanding of $6.12 billion. Six of the ten series of notes have been tendered before, as TGT has conducted four tenders prior to its latest announcement since 2013. The tender premiums vary across the bonds, with some of the largest tender premiums occurring further down the priority list. One of the most attractive tender premiums is TGT’s second priority on the list for its 6.5% notes due 10/15/37. Currently there is just over $501 million outstanding, and we would expect to see high participation in the tender for this bond given the premium of 36.4%. The average tender premium for the list of bonds is 25.8%. Currently four bonds on the list have premiums above the average which are highlighted in Exhibit 2. All tender spreads include a $3 early tender premium and we would advise investors who are looking to tender their bonds to participate on or before the Early Tender Deadline which is set for 5pm NYC time on October 6, 2020. After the Early Tender Deadline, the $3 premium is deducted from the tender spread, making the offers much less attractive, and in the majority of cases, wider than secondary spreads pre-tender announcement.
Exhibit 2. TGT Waterfall Tender and Tender Premiums
Source: Company Report; Bloomberg TRACE; Amherst Pierpont Securities
What’s With the Fitch Rating?
While Moody’s and S&P both rate TGT mid-single A, Fitch still has TGT rated at A-, where the rating has stood since 2011. Fitch has noted that in order to equalize the rating with its agency peers, it would need to see the following: consistent strong operating momentum with SSS of approximately 2% or more; lease adjusted leverage sustained under 2.0x; and greater comfort of TGT’s ability to improve price perception, particularly in apparel. While lease adjusted leverage is just at 2.0x, we note that for fiscal 2019 and 2018 it was below 2.0x. The temporary rise above the 2.0x was largely due to EBITDA contraction in 1Q due to COVID costs, such as increased hourly wages, extended paid leave, daycare assistance and increased cleaning costs. Furthermore the explosive growth in digital sales negatively impacted the gross margin, similar to peers. Should TGT be successful with the tender offer, we estimate that leverage will decline by two ticks with total debt/EBITDA at 1.6x and lease adjusted leverage at 1.8x. Additionally, quarterly SSS have been above 2.0% for the last ten out of eleven quarters. In fact, TGT’s second quarter was marked by a record 24.3% growth in SSS, with all major merchandise categories growing above 20%, including apparel. We note that apparel was the merchandise category that improved SSS the most sequentially, and an area where TGT seems to have made traction in gaining market share from competitors.
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