If you want to buy something – anything at all – the odds are pretty good that you have to visit a retailer to do it.
Whether it’s online or a physical store, retailers act as middle men of sorts that bring products and consumers together.
While this industry is rapidly changing, and the ways in which customers shop is always evolving, retailers are likely here to stay for many, many more years.
As such, one might need to look no further than Target Corporation (TGT).
Their corporate history dates way back to 1902.
Things change a lot in the retailing world, but over 100 years of operation says a lot about this company’s staying power.
Whereas there are many retailers one can choose to invest in today, the pool of profitable retailers with histories that go back more than a century is actually quite small.
Target is a retailer that sells a broad array of merchandise and food across more than 1,800 stores throughout the United States.
Retailing is typically fraught with low margins. Seeing a net margin of 1% or 2% is not uncommon in retailing. When a dollar of revenue is delivering just a penny or two of profit, a company needs to have massive volume in order to turn a decent buck of profit.
Target bucks this trend for the most part, routinely sporting a net margin that far exceeds Wal-Mart Stores Inc. (WMT), for example.
But their ability to continue posting lofty and impressive numbers for a general merchandise retailer will depend in part on whether or not they can retain their cachet.
Target’s reputation for higher-quality merchandise, supported by a higher-quality shopping experience, draws in more affluent shoppers who are looking for differentiation.
This is difficult – arguably impossible – to fully replicate online, which bodes well for a retailer like Target.
Meanwhile, the company is resting on its laurels when it comes to the shift to online sales, as Target has aggressively made strides in their online presence.
Target’s most recent guidance (January 2018) is calling for 2017 to be the fourth year in a row in which digital sales grew by more than 25%, bolstered by an expansive suite of fulfillment options. Stores were able to fulfill 70% of all online orders for the November/December 2017 period, while the recent acquisition of Shipt, Inc. improves Target’s ability to offer same day delivery.
So let’s see how all of this translates into growth. Their fiscal year ends January 31.
Revenue increased from $63.367 billion to $69.495 between fiscal years 2007 and 2016. That’s a compound annual growth rate of 1.03%.
Not really what you want to see, even when looking at a mature retailer. I think something closer to mid-single-digit top-line growth would be more acceptable.
Earnings per share advanced from $3.33 to $4.70 over this same period, which is a CAGR of 3.90%.
Again, not great. The excess bottom-line growth has been achieved by prodigious share buybacks. The company’s outstanding share count has been reduced by more than 30% over the last decade.
The Great Recession definitely negatively impacted the company. And a failed foray into Canada further exacerbated their troubles.
This all said, the future could look brighter than the past, as the company’s renewed focus on digital sales, smaller-format stores in urban centers, bolt-on acquisitions, and revamping of its stores through additional investment are exactly the moves you’d want to see them make.
Indeed, CFRA is predicting that Target will compound its EPS at an annual rate of 10% over the next three years.
I’m personally a bit less sanguine. The investment back into stores will take a bite out of cash flow; however, it could be a situation where we’re looking at a little short-term pain in exchange for long-term gain.
But what about the dividend?
Earning a better-than-average margin and raking in billions of dollars in net income doesn’t mean a lot to me as a shareholder if I’m not collecting my fair share.
Well, Target doesn’t disappoint here.
The stock is featured on David Fish’s Dividend Champions, Contenders, and Challengers document, which tracks stocks that have raised dividends each year for at least the last five consecutive years.
Not only are they featured, but they’re listed as a “Champion” due to the fact that they’ve raised their dividend for the last 50 consecutive years.
In the world of retail, that’s a lifetime. It’s mighty impressive.
Over the last decade, the company has increased its dividend at an annual rate of 16.7%.
That’s obviously well in excess of inflation, meaning shareholders have seen their purchasing power increase somewhat dramatically over that time frame.
However, the dividend growth has decelerated significantly in recent years. The most recent dividend increase was under 4%.
The expectations for dividend growth over the near term should remain muted due to Target’s need to reinvest back into the business.
But the stock does offer a rather high yield right now. So there’s been a bit of a shift that’s taken place in this stock’s dynamics over the last few years, as it’s gone from a lower-yielding stock with plenty of dividend growth to a higher-yielding stock with less dividend growth.
That’s not necessarily a problem, but it’s something prospective investors should be aware of.
For perspective on that, the stock now yields 3.4% here. And it wasn’t that long ago that the stock was yielding well over 4%.
The five-year average yield for the stock is 3%, which itself has increased as the stock’s yield stayed elevated for a lengthy period of time. Getting a 2.5% yield on this stock just a few years ago was a pretty appealing proposition.
Still, the stock’s current yield is roughly 40 basis points above even this elevated five-year average. The yield is also obviously quite a bit higher than the broader market. And it’s a yield that’s appealing in absolute terms, too.
But this dynamic has played out as Target increased its dividend much faster than underlying earnings growth allowed for.
This has caused the payout ratio to spike.
While the payout ratio is sitting at a moderate 52.1%, this is substantially higher than the sub-20% level it was at just a decade ago.
Looking at other fundamentals, the balance sheet is a bit more leveraged than I’d like to see.
The long-term debt/equity ratio is 1.01, meaning long-term debt and shareholders’ equity are essentially equal. The interest coverage ratio is just under 8.
These are good numbers, but the balance sheet could stand to be improved. This puts Target in a position that’s somewhat disadvantageous, as interest rates are rising precisely when the company is attempting to heavily invest back into the business.
Margins are, as one would expect, thin. But Target’s profitability is relatively robust.
FY 2016 showed net margin of 3.94%. And the company’s return on equity came in at 22.89%.
This is a moment of truth for Target.
They experienced massive failure a few years ago with their attempt to expand into Canada, leaving shareholders to wonder what international expansion opportunities the company has at all.
While digital sales are growing briskly, the company is still heavily reliant on the traditional B&M retailing model.
And their grocery offerings have apparently so far not connected with customers.
But if any company is equipped to deal with these issues, it’s one with over a century of experience who has also spent nearly half that time giving increasing dividend payouts to shareholders. You don’t increase dividends for almost 50 years in a row if you aren’t running a successful and growing business. It just doesn’t happen.
And they’ve been making moves to adapt to a changing consumer.
In 2014, the company announced the hiring of Brian Cornell as the new CEO and chairman, the first CEO ever hired from outside the company.
This fresh perspective has manifested itself into the changes noted earlier on.
Target is heavily investing in a holistic approach to best serve its customer, whereby digital and physical sales can seamlessly merge. And this is all while producing a better experience across all of its platforms.
With a very strong holiday season behind it, it seems that Target’s moves to improve its brand and cachet are bearing fruit.
These are some of the reasons I remain a long-term shareholder.
As these things can go, though, the stock market has already caught wind of these improvements.
The stock is up 40% over the last six months, erasing the clear cheapness the stock offered not too long ago.
However, the stock doesn’t appear to be outrageously expensive, even after that big run.
The stock is valued at a price-to-earnings ratio of 16 right now, which is a decent discount to the five-year average P/E ratio of 17.1 the stock sports.
Investors are also paying less for the company’s cash flow, relative to its three-year average.
And the yield, as described earlier, is higher than its recent historical average.
But I think some of these averages are a bit higher than they should be, due to the way the stock’s dynamics have shifted.
I valued shares using a dividend discount model analysis.
I factored in a 10% discount rate and a 6% long-term dividend growth rate.
This DGR is somewhere in between the stock’s long-term track record and the more recent dividend growth. With a moderate payout ratio, a strong holiday season, and an expected acceleration in near-term growth off of sluggish results over the last few years, it seems like a reasonable expectation.
The DDM analysis gives me a fair value of $65.72, which would indicate the stock is potentially modestly overvalued right now.
Bottom line: Target Corporation (TGT) is an entrenched retailer that’s been around for more than a century, and they’ve increased their dividend to shareholders for 50 consecutive years. Recent initiatives to adapt to a changing retail landscape, better serving a changing customer in the process, are taking shape and showing results. But after a 40% run over the last six months, the stock looks a bit expensive here. Waiting for a 10%+ pullback before buying the stock may be a very rational decision.
— Jason Fieber