Updated November 21, 2019: We are updating our original blog on Target. First, we note that Ms. Cathy Smith, stepped-down officially on November 1, 2019 and her replacement was named at the same time. Specifically, her replacement is a Target insider. At a time we believe a new and fresh perspective about Target’s PPE is needed, Target went the other way and appointed Michael J. Fiddelke, 43, as Executive Vice President and Chief Financial Officer. Mr. Fiddelke appears to have originally joined Target as a 29 year-old and has stayed loyal to Target since then.

Our view, as we outlined originally, is that Target should be evaluating a serious impairment of its physical retail stores. Such an action will take courage because any impairment would likely be a very serious hit to Target’s assets.

It would be easier to believe such courage would come from an outsider with a track record of tackling difficult accounting realities rather than a long-time insider. Mr. Fiddelke was Target’s most recent Senior Vice President of Operations and was previously the Senior Vice President, Merchandising Capabilities.

Moreover, we were also disappointed to note that Target LOWERED its audit fees last year. Given the physical retail environment’s economic challenges, it seems illogical that audit services would be reduced. Consider that Target’s competitors are increasing audit fees: Walmart. Audit fees up 47.7%, Costco audit fees up 35.2 %, TJ Maxx audit fees up 40.6%. Yet, Target’s audit fees are down 19.3%?

Under Armour recently was investigated by the SEC because of serious accounting issues. We note this because, by our analysis, Under Armour was starving its auditor’s of resources. We get concerned when we see any company reducing audit fees at a time when they are likely grappling with complicated accounting issues.

We continue to see massive retail store closures and write-downs. Business Insider reports on this as a “retail apocalypse” with 9,100 retail stores closing in the US this year.

We’ll be looking forward to seeing what Target’s auditor (Ernst & Young) publishes as Target’s Critical Audit Matters. We would hope there will be a significant discussion on valuing PPE.

On January 10, 2019, Target’s CFO Cathy Smith resigned after serving in her role for less than four years. We wish her well in her retirement, but with all the turmoil happening in retail we take a skeptical view of any 54 year-old CFO suddenly “retiring.” at one of the world’s top retail corporations. Is there something else going on?

Watchdog’s Concerns

Let’s start by giving kudos to Amazon which has no physical stores (sans Whole Foods) and earned its top position by stealing market share from brick-and-mortar physical stores like Target, Sears and others. We also note Sears filed for bankruptcy in October, 2018, which means the likely shutdown of all, or most, of the 425 Sears and Kmart physical stores.

Moreover, Target revenue for the last five years has been negative. Even without adjusting for inflation, Target’s revenue for 2018 was lower than 2014’s revenue. Since revenue is derived from its physical stores, it is clear the physical stores are not as productive as they once were.

Are you sensing the theme here? It has to do with physical stores. Every retail CFO in the USA should be closely valuing the true worth of their physical retail assets. Doing so won’t be pretty.

In accounting terms, the polite term for a serious write down of any balance sheet asset is called an “asset impairment.” An asset impairment happens when management states the previous asset value on their books is wrong. Who determines it is wrong? The CFO, auditors, CEO and/or board members. To then correct the discrepancy between the older value and newly assessed value, you file an asset impairment.

Target has 1,850 physical stores which now appear vulnerable to a major asset impairment write-down. The retail market has changed and the changes are negative for physical stores. Now may be the time to lower store asset values.

How does Target value long-lived assets? Their 10k released March 14, 2018, Target states:

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable…Fair value is measured using discounted cash flows or independent opinions of value, as appropriate. We recorded impairments of $91 million, $43 million, and $54 million in 2017, 2016, and 2015, respectively…

We note that Target has disclosed an average of only $85 million in impairments a year over the last five years – on a PPE base of $18 billion in non-land PPE assets. That’s about a 0.5% in impairment value. Looking at TGT’s peers, we note Walmart took a $569m impairment when closing Sam’s stores and Sears took over $1bn in impairments in the last four years.

While Target has consistently identified its disclosure controls “as effective,” starting in May 2010, TGT has added non-standard language ten times disclosing its efforts to implement an ERP system (three disclosures were over the last three quarters). The most recent disclosure came in the November 2018 10Q disclosing it is moving from “mainframe” computers to a more “modern” platform. This does not inspire confidence.

Most likely there are serious internal discussions going on at Target about the asset value of stores. The CFO resignation and Auditor (EY-1931) fees might be evidence of a fissure at Target. From 2017 to 2018 outside audit fees shot up 20.5%.

If our concerns about a possible impairment are valid, one might look at a CFO retirement as a delaying tactic or evidence of accounting disclosure conflicts within management.