Target (NYSE:TGT) shares have been on fire in 2019. Shares in the retailer are up 35% year-to-date, from about $66 in January to approximately $87 today. While the stock continues to trade a lower valuation than its peers, investors have more confidence in its future prospects.
Regarding the future, Target faces many headwinds. The never-ending growth of Amazon (NASDAQ:AMZN), threatens the “big box” retail model. Within the big box realm, competition from Wal-Mart (NYSE:WMT) also threatens Target’s long term prospects.
But do not take the low valuation of TGT stock to mean weak prospects. Read on to find out why Target may still be a buy after a 35% rally.
Target’s Strategy Is Paying Off
Pressure from Amazon has prompted Target and Wal-Mart to invest billions in order to stay relevant. As stated in their March 5, 2019 CFO presentation, after sales declines in 2016, Target was motivated to change course in order to resume growth.
Unlike Wal-Mart’s acquisition-driven strategy (Jet.com, Flipkart), Target focused on store reinvestment. The company remodeled stores, expanded their selection of owned and exclusive brands, and adapted to Amazon-related “same day delivery” pressures.
In late 2017, Target acquired delivery service Shipt for $550 million. The Shipt purchase provided the infrastructure to offer same-day delivery in the majority of their stores. The success of this deal highlights Target’s ability to remain relevant in an Amazon-dominated retail environment.
Target’s strategy has paid off. Comp sales and traffic were both up 5% in 2018. This indicates Target is making the right moves to protect their market share.
Solid Future Prospects for TGT
Target’s guidance calls for low-single digit sales growth in the next year. While this is not too exciting, it does indicate confidence Target can at least keep up in an increasingly e-commerce-driven retail environment.
Target continues to expand in the e-commerce realm. Digital sales are up from $3.9 billion in 2017 to $5.3 billion in 2018.
For brick and mortar stores, Target’s “small format” strategy helps maintain market share. Opening smaller locations in affluent, densely populated areas maintains Target’s image as the cosmopolitan big box store.
Based on the Target CEO’s presentation in March, Target has the highest concentration of small-format stores in the New York, Washington, D.C., Los Angeles, and San Francisco metro areas. Heavy presence in America’s most affluent areas continues to be a positive factor in Target’s future growth and profitability.
Valuation: Target Stock Trades at a Discount to Peers
TGT stock trades at lower earnings multiples than competitors Wal-Mart and Costco (NASDAQ:COST):
- Forward P/E: TGT trades at 14x forward earnings. WMT trades at 22.5x forward earnings, and COST trades at 32.7x forward earnings.
- EV/EBITDA (trailing 12 months): TGT’s EV/EBITDA ratio is 8.4, while WMT and COST trade at EBITDA multiples over 10 (12.2 for WMT, 19.5 for COST).
Despite this valuation discrepancy, TGT has higher EBITDA margins (10.1%) than both WMT (6.8%) and COST (4.2%), and has a net income margin of about 4.5% (compared to 1.6% for WMT, 2.4% for COST).
The TGT stock discount continues to be a mystery. In a recent article, InvestorPlace contributor Will Healy pointed out a strong reason behind the discrepancy. With the failure of their Canadian expansion a few years back, Mr. Market still lacks confidence the company can continue to grow.
But what Target lacks in “growth story,” it makes up for in value. Not only is TGT stock undervalued relative to its peers; Target stock is a solid dividend play.
TGT Continues to Be a Dividend Aristocrat
Target stock has paid a dividend since 1971. Not only that, the dividend has a 5-year CAGR of 9.79%.
Compared to peers, TGT stock pays a higher dividend. Target’s yield of 3% beats out WMT (1.8%) and COST (0.96%).
Despite plowing billions of dollars back into the business, Target continues to make return of capital a high priority. In 2016 and 2017, the company bought back $3.2 billion worth of TGT stock. These buybacks helped boost EPS by about 8% (TTM EPS of $5.74, versus EPS of $5.32 in 2018).
As stated in the CFO presentation, Target is committed to returning excess cash within the limits of their middle-A credit rating. This highlights Target’s continued prudent capital allocation beneficial in the short-term (buybacks/dividends) and the long-term (store reinvestment).
Bottom Line: TGT Stock Has Risks, But Is Still a Buy
The Amazon-driven “retail apocalypse” is a long-term risk to Target stock. But strategic moves are helping Target keep up in a tough retail environment.
Despite solid earnings, TGT stock is still a bargain relative to peers. Add in a healthy buyback policy and high-yielding dividend, and Target stock offers investors a strong opportunity.
Target’s next earnings call is in August. Investors buying the stock today face the risk of priced-in expectations, and could see declines if earnings fail to excite investors.
This makes Target stock a cautious buy. There may be better value purchasing shares down the road, but investors today may still want to initiate a position at the current price.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.
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