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Home Depot, Target could see CDS reverse course

Thursday, 11 Oct 2012 | 12:01 AM ET

By Melissa Mott

Oct 11 (IFR) - The CDS of big box retailers Home Depot and Target have tightened significantly in recent months, but have the potential to widen in the months ahead as consumer spending is expected to increase only moderately.

The US Fed's Beige Book on Wednesday cited flat consumer spending growth in September, and with a weak holiday shopping season expected, the two retail giants could see their credit default swaps reverse course.

Home Depot (A3/A-/A-) and Target Corp (A2/A+/A-) are both quality names from a credit perspective, with solid balance sheets, stable earnings growth and good customer loyalty.

Market sentiment has helped tighten the credit default swaps of Home Depot to 42bp from 52bp in July, while Target's CDS has tightened to 38bp from 41bp over the same period. Their CDS trade at tight levels relative to other investment-grade names, and are usually resistant to outside factors that provoke spread widening in lesser-rated entities.

But despite the solid fundamentals, that outperformance is likely to fade. Moderate CDS widening can be expected if consumer spending continues to advance at a lackluster pace.

TROUBLE AHEAD, TROUBLE BEHIND

There are plenty of other problems, too, including the looming fiscal cliff, elevated unemployment, stagnant wages and rising food and gasoline prices.

With that as a backdrop, retailers such as Home Depot and Target have adopted a more guarded outlook in the near term - and September same store sales data back up those concerns.

If we extrapolate from the self-published figures of a mix of big box, specialty and other retailers, we can get insight into how consumers feel about spending - and sense what to expect in the months ahead.

Target's September store sales came in at 2.1%, as expected, but compare to 5.3% last year. It does, however, place them on track to meet conservative goals. For October, Target forecasts low to mid single digit same store revenue growth.

But the retailer had already planned for a stronger first half of 2012 versus the second half, and its CFO John Mulligan said at an analyst presentation last month that he expects "uncertainty" due to the fiscal cliff and presidential election, which is causing consumers to be cautious.

At the same presentation, Home Depot CEO Frank Blake noted the tentative nature of consumers who are strapped for cash and less likely to invest in larger home remodeling projects.

Even as the nascent housing recovery looks to gain traction, Blake said that many people were still "underwater on their homes," and less likely to "put money into it and think you'll get a return."

With expectations for comparable store sales growth in the low single digits, Home Depot has remained conservative in its opinion of the slow economic and housing recovery - and is linking its future growth to the GDP instead.

HO HO HUM

With shoppers already cash-constrained, forecasts for the upcoming holiday season are less than enthusiastic.

The National Retail Federation said last week that 2012 holiday sales will rise by an anemic 4.1% year on year, while the International Council of Shopping Centers has put it even lower at 3.0%.

Ratings agency Moody's also anticipates a lackluster holiday season, and expects Q4 sales will grow at their slowest pace since 2009 when, according to their data, the figure was a paltry 0.815%. The agency cites the slow increase of non-wage income as rising prices outpace wages - and as consumers become more reluctant to take on debt.

That reluctance to take on debt will curb spending habits, whether holiday or home project-related, and warrants the cautionary outlook from retailers.

This will eventually be reflected in the CDS of Home Depot and Target, in the form of widening spreads. And that widening could be spurred on further if consumer spending continues to be restrained. But the companies' solid fundamentals should limit any moves in that direction.

(Melissa Mott is a senior IFR analyst; Editing by Marc Carnegie)

((melissa.mott@thomsonreuters.com; Reuters messaging: melissa.mott.thomsonreuters.com@reuters.net))

Keywords: US RETAIL CDS/

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