Investor optimism keeps DH stock percolating: analysts favor separate operations; Ulrich stands by 'boundaryless' formula - Dayton Hudson CEO Robert Ulrich - The Power Retailers: Target

Discount Store News, April 1, 1996

Dayton Hudson stock continues to confound Wall Street, rising to a new 52-week closing high of March 15-the day after it reported a 28.3% decline in net income for '95-even though it has not yet found the solution to Mervyn's problems, and has failed to improve its earnings over the past several years.

For the first time, however, Dayton Hudson has publicly stated that Mervyn's could be sold if its performance fails to improve in the first half of N. Even the department store division could be so d several years down the road if it fails to improve following last month's management shakeup.

What remains to be seen is whether investors bid up the price of stock because they accept the company's assurance that Mervyn's will turn around, or the acknowledgement that it could sell Mervyn's if it doesn't, or they are comforted by the company's plan to cut $170 million in expenses to improve '96 profits.

What is beyond question is that they didn't push the stock to new highs because of DH's'95 results.

Net income for DH fell 28.3% to $311 million, or $3.89 a share, from $434 million and $5.52 a share in '94 and below its EPS in '89 of $5.35. Operating income fell 17% to 10% billion from $1.2 billion

Operating income for Target fell 2% in '95 to $179 million from $732 million in '94. Its operating profit margin fell to 4.5% of sales from 5.4% in '94. Much of that slump stemmed from sales of commodity goods and severe price cutting that hurt even Wal-Mart's profits, but higher wage rates also reduced profits.

Target sales rose 16% to $15.81 billion from $13.6 billion in '94. Comp store sales rose 6% for the year.

Despite ongoing attempts to fix Mervyn's, the division showed another operating margin decline this time to 2.2% for '95 from 4.3% the previous year. Operating income fell to $100 million from $206 million in 94. The department store division also saw its operating margin fall to 5.76% from 8.2% in '94. The overall corporate operating margin slipped in '85 to 4.3% from 5.6% in '94.

To improve profits in '96, DH has embarked on a drive to cut expenses by $170 million, including $100 million from Mervyn's, $50 million from Target and $20 million from the department store division. The Target cuts include freezing the salaries of top executives and curbing travel and entertainment expenses.

Both Standard & Poor's (in December) and Duff & Phelps (in January) cut their ratings on $4.8 billion in DH debt, potentially raising its cost of borrowing money, and Moody's (also in January) placed its debt up for review for a possible downgrade. They based their moves largely on the problems at Mervyn's.

DH obviously is paying more for credit, said Jerry Hirschberg, director, corporate ratings for S&P, but that wouldn't show up in the numbers. The debt rating for DH is several notches below that of Wal- Mart, which gets the highest SAP retail rating.

Nonetheless, DH had no trouble floating a $300 million debt issue in early February, paying only one point above the interest rate for seven-year Treasury bonds. Investors were climbing over each other to get a piece of the action. Last year, it also sold its credit card receivables, raising $400 million. Its long-term debt rose to $4.96 billion from 4.49 billion in '94.

DH filed a shelf registration in January for $1 billion more in securities, raising the total it can issue to $1.27 billion.

Wall Street would like to see DH broken up and its three divisions operating as separate companies in order to maximize shareholder value. Until the last month's head-quarters statement, Ulrich had been stoutly insisting that he would not break up the company, despite widespread speculation in January '95 that the May Department Company would buy the 64-unit department store division, which consists of Dayton's, Hudson's and Marshall Field's stores. Ulrich's vision has been to leverage the strengths of the three divisions into what is known at DH as "the Power of One," creating a boundaryless company that eliminates layers of management and shares systems and merchandising expertise.

That speculation last year caused a sharp spike in the price of DH stock, indicating that the investment community would favor selling the department stores for perhaps $2 billion $3 billion. That would enable DH to improve its highly leveraged balance sheet and invest more into ,expanding Target, the engine that drives the company.

If DH were to sell its department stores, it could use the proceeds to pay down debt and give it more time to fix Mervyn's. The company needs to regain market share, as the 5% decline in '95 comp sales suggests, as well as cut expenses, said Dean Ramos, retail analyst for Dain Bosworth, Minneapolis. If DH were to try to sell Mervyn's, it would have to take a huge write-off, akin to what Melville did when it sold Marshalls at a 75% discount.

Target, which accounts for more than 60% of DH's sales and operating income, isn't constrained for expansion capital because of its sister divisions. It will still get two-thirds of DH's '96 capital budget of $1.4 billion. ,