Published October 27th, 2016 by Bob Ciura
Target Corporation (TGT) started out as a single store in Roseville, Minnesota, all the way back in 1962. In the five decades since, the company has stuck its core belief—expect more, pay less.
Target aims to fulfill the needs of every customer. It does this by delivering great values, exceptional experiences, and constantly innovating over time to meet the needs of a changing marketplace.
Today, Target operates nearly 1,800 stores and the stock has a market capitalization of $39 billion. Target generates more than $73 billion of annual sales. It is a very shareholder-friendly company that is committed to paying a dividend and raising the dividend consistently each year.
Target has raised its dividend payments for 45 consecutive years. This makes the company one of only 50 Dividend Aristocrats – stocks with 25+ years of consecutive dividend increases in the S&P 500. You can see the full list of Dividend Aristocrats here.
Target stands out for more than just its impressive dividend history… Several relevant metrics for the company are below:
- Low price-to-earnings ratio of 13.3
- Above-average Dividend yield 3.5%
- Conservative payout ratio of 42%
These factors help Target stock to rank in the Top 10 using The 8 Rules of Dividend Investing. These metrics are not lost on the greater dividend growth investing community – Target is one of the 10 most popular dividend growth stocks among dividend growth bloggers.
Keep reading this article to learn more about Target’s investment prospects, competitive advantage, and growth potential.
Target operates in five core segments, which are:
- Household Essentials
- Food & Pet Supplies
- Apparel & Accessories
- Home Furnishings & Décor
Target is diversified across each segment. It generates a significant portion of total sales from each of its five businesses.
Source: 2015 Annual Report, page 2
The company’s diversification has helped it generate growth over the past several years. Interestingly, another factor that has helped Target in the current environment is that it is not diversified geographically.
Target generates all of its revenue and profit from the U.S., as it no longer operates stores in Canada. Target tried to expand into Canada, but eventually closed all of its stores there. Customers simply did not take to the Target experience, and the experience cost Target $2 billion.
Despite these various challenges, Target has done a good job growing the core U.S. business. If we exclude one-time financial charges taken against earnings in recent years, Target’s adjusted sales and earnings-per-share growth is steady.
Source: 2015 Annual Report, page 2
Target has displayed solid growth over the long-term. In the past decade, the company grew earnings-per-share by 5.6% compounded annually. This may not seem impressive, but this period includes the Great Recession. It also includes Target’s hacking scandal and its ill-fated Canada expansion effort.
The fact that the company has continued to grow in spite of all this is a testament to its business model and execution.
Growth Prospects & Current Events
Going forward, Target has two key growth catalysts to look forward to:
- Small stores
The boom in Internet retail caught brick-and-mortar retailers off guard, but Target is quickly catching up. Target has invested heavily in its digital platform, to deepen engagement with customers online. The results speak for themselves: Target’s digital sales soared 30% last year. Strong results in this area have continued into 2016. Target’s e-commerce sales grew 16% last quarter.
Separately, another compelling growth catalyst for Target is in small stores. These are stores that are much smaller than the traditional Target super-stores. The reason why Target is aggressively investing in small stores is because they can give the company access to large cities. Big cities cannot offer the square footage needed to build a large Target location. With small stores, Target has access to millions of new potential customers in large cities and urban areas.
These ‘flex-format’ stores as management refers to, are perfect for dense cities and suburbs. Over the summer, Target opened up new flex-format locations in Philadelphia, Chicago, Boston, and New York City. Target’s small-store count is up to 20, and it plans to add nearly 20 more next year.
Finally, the upcoming holiday shopping season should be another tailwind for Target. Reports indicate that the fourth quarter could be a strong one for retailers. According to The National Retail Federation, total sales this holiday shopping season are projected to rise 3.6%, excluding autos, gas, and restaurants. This would be above the average growth rate in the years since the Great Recession.
Competitive Advantages & Recession Performance
Target’s long track record of growth and consistent dividend increases indicate it has a strong competitive advantage that can stand the test of time. Its main competitive advantage is the positive experience it offers customers, which keeps them coming back.
In the discount retail industry, price is critically important. But Target often does not have the lowest prices, particularly when compared with its bigger rival Wal-Mart Stores (WMT).
This should not come as a surprise, since Target is much smaller than Wal-Mart. Wal-Mart is the largest retailer in the world and generates nearly $500 billion in annual sales. As a result, Target needs to compete in a different way.
It does this with a mix of low prices, and clean stores. The Target experience generally has a cleaner, friendlier feel than Wal-Mart, which has come under scrutiny in recent years because of the condition of its stores. Although this is anecdotal, it has had a tangible effect in recent years. These qualities keep shoppers coming back to Target, even if it does not offer the lowest price on all goods.
Target’s earnings-per-share dipped only mildly during the Great Recession of 2007-2009, and it managed a quick recovery:
- 2007 earnings-per-share of $3.33 (new high)
- 2008 earnings-per-share of $2.86 (14% decline off high)
- 2009 earnings-per-share of $3.30 (1% decline off high)
- 2010 earnings-per-share of $3.88 (new high)
Target displayed remarkable resiliency during the Great Recession. This stands to reason, since discount retail is a defensive industry.
Valuation & Expected Total Returns
Target stock has a price-to-earnings ratio of just 13.3. This is a significant discount to the S&P 500, which has a price-to-earnings ratio of 24.7.
Since 2000, Target stock has traded for a price-to-earnings ratio of 15. This implies Target is trading at an 18% discount to its historical valuation, and it is even more undervalued compared with the S&P 500.
This means investors are likely to earn strong returns. Not only is there an opportunity for margin expansion, but earnings-per-share are likely to grow.
Target currently pays a 3.5% dividend yield, which will add to future returns. If Target grows at its 10 year historical rate of ~5.5%, investors will see total returns of 9% a year before valuation multiple gains. There’s a good chance Target will grow faster than it has over the last decade, if it can avoid the costly mistakes (Canada expansion, data breach scandals, etc.) that have hampered growth in recent years.
As a result, between valuation multiple expansion, earnings-per-share growth, and the dividend, it is not unreasonable to foresee 10% annualized returns going forward for Target stock over the next several years.
Target stock has something to offer all dividend investors. It has an above-average dividend yield, plus high rates of dividend growth each year. It is a Dividend Aristocrat, and has increased its dividend for more than four decades in a row. The stock also appears to be undervalued.
As a result, Target is a compelling investment for investors interested in current income, dividend growth, value, and total returns. The image below shows Target’s historical dividend yield.
As you can see, buying Target for a dividend yield of around 3.5% is a historically rare opportunity. It is all the rarer when one considers today’s low interest rate environment. The last time investors had a chance to buy Target stock for yields of 3.5% was in the late 1980’s.
Target is one of the few high quality blue chip dividend stocks that is a bargain at current prices on a historical basis. The company ranks as a buy using The 8 Rules of Dividend Investing.