Published by Bob Ciura on October 19th, 2017
Every year, we publish a review of each of the Dividend Aristocrats. The Aristocrats are a group of companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
Target (TGT) is a Dividend Aristocrat, and a rare one at that.
It is the second-highest yielding Dividend Aristocrat, behind only telecom giant AT&T (T). Today, Target and AT&T are the only two Dividend Aristocrats with at least 4%+ dividend yields.
Plus, Target has a long history of dividend growth. It has paid 200 quarterly dividends in a row, and has increased its dividend for 46 consecutive years.
Target is a unique combination of a high dividend yield, and dividend growth. And, the stock appears to be significantly undervalued at its current price.
This makes Target an attractive buy for value and dividend growth investors.
Target is a discount retail giant. It has a market capitalization of $32.8 billion. Today, it operates more than 1,800 stores in the U.S., as well as an e-commerce business.
It has a diverse product lineup, and sales reached nearly $70 billion last year.
Source: 2016 Annual Report
This is a difficult period for Target, and all of retail. The escalating threat of Internet retailers is disrupting the entire brick-and-mortar retail industry. Target’s comparable sales fell 1% in the fourth quarter of 2016.
And, Target management warned investors that earnings-per-share would fall as much as 20% in 2017, as the company would need to spend more to turn things around.
The good news is, the turnaround appears to be taking shape. Target beat analyst expectations last quarter, for both revenue and earnings-per-share.
Revenue of $16.4 billion rose 1.6% year-over-year, thanks to a 1.3% increase in comparable sales. Earnings-per-share increased 14% for the second quarter, to $1.23.
Target also gave better-than-expected guidance for the remainder of the year. Target expects its full-year 2017 comparable sales to be down 1%, to up 1%. Analysts had expected a steeper decline.
For third quarter 2017, the Company expects both GAAP EPS from continuing operations and Adjusted EPS of $0.75 to $0.95. Target also expects adjusted earnings-per-share of $4.34 to $4.54 for the year, which leaves enough room for continued dividend increases.
Target performed poorly in 2016, but is off to a much better start to 2017. Going forward, there is a good chance the company can sustain its turnaround. It has launched several initiatives to return to growth. First, it is in the process of redeveloping hundreds of stores. To do this, it is modernizing layouts, and adding new product categories.
Source: Earnings Presentation, page 84
Target expects it can achieve a 2%-4% lift in sales for each store it renovates. By 2018, the company expects to have completed reimagining on over 350 of its stores. By 2019, it will have reimagined over 600 stores, accounting for one-third of its total store count.
Another major growth catalyst for Target is its small stores. After closing its short-lived Canada stores, Target is now entirely based in the U.S. This means it must find ways to reach new customers. One way is through small stores. These are stores with much less square footage, in places that cannot provide the necessary space to build a large store.
Target’s small stores are being opened under the CityTarget and TargetExpress banners. These small stores are located in areas that see high traffic, such as densely-populated large cities and college campuses.
By 2019, Target expects to open over 100 small stores, tripling the number of small stores currently in operation.
Source: Earnings Presentation, page 77
Lastly, Target has a plan to fight back against Amazon (AMZN), by building its own e-commerce platform.
Target’s comparable digital sales increased 32% last quarter, double the growth rate from the same quarter last year. And, Target recently expanded its next-day delivery of essential items to eight new U.S. cities.
Competitive Advantages & Recession Performance
Target operates in a difficult industry. Retail does not offer many durable competitive advantages, and is highly competitive. For consumers, retail brands often take a back seat to price and convenience.
That said, Target does enjoy competitive advantages. Most importantly, it has massive distribution and scale capabilities, which allow it to keep prices low.
In addition, Target operates in a defensive niche of the retail business. Discount retail tends to hold up relatively well during economic downturns, when consumers will typically shift down from higher-priced retailers.
Target’s earnings-per-share during the Great Recession are as follows:
- 2007 earnings-per-share of $3.33
- 2008 earnings-per-share of $2.86 (14% decline)
- 2009 earnings-per-share of $3.30 (15% increase)
- 2010 earnings-per-share of $3.88 (17% increase)
- 2011 earnings-per-share of $4.28 (10% increase)
Target was remarkably resilient during the Great Recession. It suffered a 14% decline in 2008, but followed this with three consecutive years of double-digit earnings growth.
Valuation & Expected Returns
One of the appealing aspects of Target, is its low valuation. Based on its adjusted earnings-per-share, Target has a price-to-earnings ratio of just 11. Meanwhile, the S&P 500 Index has an average price-to-earnings ratio of 25.6.
Target is valued at less than half the S&P 500 valuation. The stock appears to be significantly undervalued, given its high profitability and growth potential. An expanding valuation could generate significant returns. If Target’s price-to-earnings ratio expanded to 15, Target stock would return approximately 36%.
In addition, Target can generate returns from earnings growth and dividends. According to ValueLine, Target increased earnings-per-share by 7% per year, from 2001-2016.
The company may not reach 7% earnings growth during this period of higher capital investment. But, mid-single digit earnings growth seems to be a reasonable set of expectations.
A breakdown of total returns is as follows:
- 1%-2% revenue growth
- 2%-3% share repurchases
- 4% dividend yield
Combined with a 4% dividend yield, Target’s total returns could reach 7%-9% per year, not including returns from an expanding price-to-earnings ratio.
Target is struggling during this time of particularly fierce competition. But it has a long history of growth and steady dividends. The company’s turnaround initiatives are gaining traction. Target has the potential for a return to growth over the next few years.
Plus, Target is highly profitable, meaning it can return significant amounts of cash to shareholders. The company is able to buy back its stock at a far lower price, and shareholders are paid well to wait for the turnaround