Target would have us believe that it wouldn’t be much better off in the market if the company had spent $15 billion more the last few years on its stores, warehouses and websites.
That figure is what the company either has spent or intends to spend buying back its own stock rather than investing in its business. That’s in addition to the dividends it pays, so far this year worth about $666 million.
It’s money the company could have invested back into its business if it saw opportunities that looked like they would pay off.
Even for a very large company like Target Corp., $15 billion is a lot of money, of course. But one lesson out of the Minneapolis-based company’s recent history is that spending a lot of money isn’t the same thing as investing it. Spending is easy. Investing is hard.
Since January 2012 Target has bought back about $8.8 billion worth of stock, through the recent announcement of the latest buyback. From the looks of its capital plan, the board could be asked to approve more stock buybacks as soon as next year.
It’s worth putting the $15 billion into some context. It’s enough to fund a few big expansions just like the company tried a few years back in Canada, when it opened 124 stores at more or less at the same time.
It’s more than Amazon.com has invested in its business over the last three full fiscal years, including the cost of developing the software that makes its websites so robust and enables warehouses that can pick and pack items for quick delivery. It’s also more than twice what Costco invested in its business over the same period.
These companies have bought back stock, too, but not like Target does. In 2015 Target generated cash flow from operations of close to $6 billion, although some of that money came from selling its in-store pharmacies. Most of it, nearly $3.5 billion, went to buying back shares.
In 2014 the company had suspended its share buybacks, but 2013 looked a lot like 2015. That included taking a lot of the $4.2 billion in net proceeds from selling its credit card receivables and buying back stock with it.
The conventional explanation for why big companies buy back stock is that it gooses earnings per share, as the profits of the company in any given accounting period get divided by fewer and fewer shares outstanding.
Target can’t credibly deny that earnings-per-share arithmetic isn’t part of its thinking, but it’s not the place it starts. “As we determine Target’s capital deployment priorities, we focus first and foremost on investing in our business to drive growth and strong returns,” said Chief Financial Officer Cathy Smith, in a quick follow-up e-mail to a conversation with Target executives last week.
Making sure the capital invested in the business generates a decent return is, of course, a basic task of running a business. This kind of spending generally gets called capital expenditures, and what it means is buying something that’s expected to last for a while, like a machine or store fixtures, or technology like software. What’s not included is every day, cost-of-doing-business items, things like the wages and benefits of the employees.
In Target’s case, money is invested in things that meet, as the company put it, “financial and strategic” criteria. The financial side is easy to grasp. That’s green lighting projects that will return more in expense savings or additional profits than it costs the company to get the capital.
The strategic part is more interesting. What it means here is that Target approves projects when a number at the bottom of the spreadsheet can’t really justify it, going ahead with what the company called “doing the right thing.”
What’s surprisingly missing in this discussion is how Target doesn’t put share buybacks on the same spreadsheet to evaluate along with capital projects. It’s more or less conventional corporate finance thinking to do so, as it’s possible to calculate a return from buying back the company stock, for starters by counting the dividends the company doesn’t pay as stock is vaporized in a buyback.
In Target’s case, share buybacks don’t compete with capital projects for the same dollar. Rather, the explanation is that Target is a mature company that generates more capital than it could profitably put back into the business. If not buying back shares, what should management do with the capital left over?
The era of rapid expansion of the company’s store base, of banging out 100 new, more or less identical suburban stores, is long over. The new thinking, the “flexible format” store, means stores of different sizes and merchandising mix, customized for unique neighborhoods, a process that just can’t go that fast.
Target is also investing a lot to improve the movement of products through its whole system, up to and including the customer’s doorstep. For this holiday season about 1,000 of its stores will be able to ship customers items ordered online, turning the back of the store into a micro e-commerce fulfillment center.
If everything works out according to plan, the company told investors and analysts earlier this year, Target will invest $2 billion to $2.5 billion in capital items every year. It would take about $3 billion and use it to buy back shares, slowing down share repurchases if it looks like its “A” credit rating is at risk.
Buying back $3 billion of stock per year will have a nice positive effect on earnings per share, too. In fact, if the company achieves its goal of double-digit EPS growth, half the explanation will be the reduced number of shares due to the buybacks.
At other big companies, meanwhile, the cash piles up. At Amazon.com the cash and marketable securities at last count amounted to more than $16 billion.
Asking Amazon.com executives how they intend to generate a return with that shareholder money is a better management question than asking Target’s why they want to buy back more stock.