WMT - Target Stock: 35% Price Upside

2023-09-14 08:27:56 ET

Summary

• Target has raised dividends for 54 consecutive years and has the healthy cash flow to continue annual raises.
• There is a disconnect between current price and fair value. There is a potential upside of 35% going into 2024.
• Improved macroeconomic conditions and consumer spending trends indicate continued growth potential for Target despite short-term noise.

Thesis

Target Corporation ( TGT ) has experienced a poor year, marked by a YTD decline of nearly 16%. This contrasts sharply with the S&P 500 performance during the same period. I believe there is a disconnect between fair value and the current price, which is why I believe we have an interesting buy opportunity available to us now.

TGT continues to adapt to market conditions and remains cash flow strong. They are able to comfortably support the dividend and maintain their status as a dividend king that has raised payouts for 54 consecutive years. I believe the current trading range is below fair value and now presents an attractive opportunity to get in at a decent starting yield greater than 3%.

Financial Positioning

Target Corporation recently disclosed its second-quarter 2023 financial results, which showcased profitability despite lighter sale volume than projected. The company reported second-quarter GAAP and Adjusted EPS of $1.80, marking an insane 357.6% increase from $0.39 in the same period last year. This exceeded expectations and surpassed the high end of the company's guidance range, demonstrating the agility of Target's team and the resilience of their business model.

Unfortunately, all comparable metrics for the second quarter weren't as strong because overall comparable sales declined by 5.4%. As a hedge to this, it seems that TGT experienced continued growth in reoccurring businesses, such as Essentials & Beauty and Food & Beverage as these categories were able to offset declines in discretionary categories.

Target now anticipates comparable sales to decline in a wide range around a mid-single-digit rate for the remainder of the year. The full-year GAAP and Adjusted EPS guidance has been revised to a range of $7.00 to $8.00 per share, compared to the previous range of $7.75 to $8.75 per share.

We also received reassurance that the company remains committed to its long-term investments and strategy, positioning itself to deliver sustainable, profitable growth in the coming years.

"Our second quarter financial results clearly demonstrate the agility of our team and the resilience of our business model, as we saw better-than-expected profitability in the face of softer-than-expected sales. With the benefit of a much-leaner inventory position than a year ago, the team was able to quickly respond to rapidly-changing topline trends throughout the second quarter, while continuing to focus on the guest experience." - Brian Cornell, CEO

TGT is also investing cash back into their stores to help cater to growth and profitability. They plan to invest between $4B - $5B into the business through remodeled stores and supply chain capabilities.

Dividend King

TGT provides investors with a forward dividend yield of 3.6% which surpasses the sector median of 2.7%. This attractive dividend yield positions TGT favorably for income-seeking investors. This is especially true when you take into account that TGT has already established and crossed the milestone of being a dividend king. Dividend kings are companies that have consistently increased their dividend payouts for over 50 consecutive years. TGT's dividend raise streak currently sits at 54 years and there's no indication of slowing.

Target continues to meet profitability expectations, so I believe we will see continued dividend increases for years to come. Don't let the short-term market conditions cloud your outlook: TGT is rock solid and their dividend payout ratio still sits below 60%. Using the increased data over the last 5-year period, TGT averages an 11.6% dividend growth rate.

Increased Staple Spending

Improving macroeconomic conditions, encompassing lower inflation, rising real wages, and consumer confidence has resulted in higher spending within discretionary categories. Don't be fooled! We see firsthand how unhappy people have become with the rise in costs for groceries, housing, and overall affordability. Somehow, though, people still find the cash to spend at businesses like TGT, and we have the data to prove it.

According to Bank of America's economic team, they expect consumer spending to rise 2.3% in 2023 (up from 2.1% previously) and 1.1% in 2024 (up from 0.1% previously). According to a separate analysis conducted by Deloitte , retail sales are still growing in the face of uncertain economic times. That same study shows an increase in consumer spend alongside an increase in prices that consumers are willing to pay.

Target has the inventory and range to hugely benefit from the uptick in consumer spend. Short-term noise aside, TGT remains a strong contender that is capable of providing exceptional returns when taking this consumer data into consideration. Seasonal and trend related sales will influence TGT's total revenue going into the year-end as well. The sale of merchandise tied to popular media content may contribute to improved performance, but these are only outliers to be aware of rather than dependent on. With that said, do expect the next quarter's earnings to be strong.

Valuation Comparison

Assessing TGT's valuation, it is clear that the stock has underperformed over the past year, with a YTD slump of nearly 16%. In contrast, competitors like Walmart ( WMT ) have achieved positive returns. However, TGT's forward earnings multiple stands at 16x, which closely aligns with its five-year average of 18x.

Comparatively, Walmart trades at a significantly higher forward earnings multiple of 30x. Despite TGT's lower revenue growth relative to WMT, its gross margins remain on par. As it stands, Dollar Tree ( DLTR ) also has a higher PE at 19.5x. In my opinion, this may indicate that TGT is currently trading below a fair valuation.

To further reinforce this, we can use a discounted ash flow calculation to come up with a fair value estimate as well. According to Seeking Alpha's TGT earning tab, the estimated EPS estimated to close out 2024 comes in at 7.6. We can also take TGT's average 5-year revenue CAGR of 8.5% and take a conservative estimate that they will level off growth at 6.9% afterward to match the consumer staples index.

Using these inputs, we determine a fair value estimate of $167 per share. From the current price, this would represent a potential upside of 35%. A 35% potential upside combined with a well-supported dividend yield of 3.5% makes this a great opportunity to start a position in TGT if you aren't holding any shares already. If you do hold shares like myself, I think these are great levels to accumulate more.

Conclusion

Target Corporation has faced a challenging year with a significant year-to-date decline in its stock price, in stark contrast to the broader market's performance. However, this situation presents an intriguing buying opportunity.

While comparable sales have declined, the company's adaptability and focus on essential categories demonstrate resilience. Furthermore, Target's status as a Dividend King, with a strong upfront dividend yield and consistent increases, positions it favorably for income-seeking investors.

Improved macroeconomic conditions and consumer spending trends indicate growth potential. Valuation comparisons and discounted cash flow calculations suggest that Target may be trading below its fair value, with a potential upside of 35%. With these factors in mind, it appears to be an opportune time to consider a position in TGT or accumulate more if already invested, despite the recent market challenges.

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