Published February 28th, 2017 by Nicholas McCullum
Target (TGT) investors have seen the company’s stock go through a prolonged downturn over recent months. Unfortunately, this trend appears to be continuing.
On February 28, Target reported earnings that seriously disappointed. The stock fell from $67 to $57.50, and currently sits around ~$59.
Source: Yahoo! Finance
It is important to remember that Target’s stock price is not necessarily indicative of the company’s actually per-share value.
Sometimes, stock prices become irrationally disconnected from the value of the underlying business. This is a good thing for the opportunistic investors.
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
– Warren Buffett
It’s important to remember that Target is a high quality business with a strong history of rewarding shareholders. Target has raised its annual dividend payments for 46 consecutive years, which makes them a member of the elite Dividend Aristocrats (companies with 25+ years of rising dividends).
This article will discuss why Target’s decline presents a buying opportunity, rather than a reason for investors to fear.
Breaking Down the Earnings Release
Upon initial perusal, Target’s earnings report seems fine. Here are a few of the company’s key metrics, as quoted directly from their press release:
- Fourth quarter comparable sales decreased 1.5 percent, compared to the guidance range of (1.5%) to (1.0%).
- Fourth quarter comparable digital channel sales increased 34 percent, contributing 1.8 percentage points of comparable sales growth.
- Fourth quarter GAAP earnings per share (EPS) from continuing operations of $1.46 and Adjusted EPS of $1.45, compared with the Company’s guidance range of $1.45 to $1.55.
- For full-year 2016, GAAP EPS from continuing operations declined 12.7 percent to $4.58, reflecting a loss of $0.44 on the early retirement of debt.
- Full-year Adjusted EPS increased 6.7 percent to $5.01.
There are a few things to cause concern – most notably declining same stores sales and a reduction in GAAP earnings-per-share.
However, there are also a few bright spots from this earnings release which arguable offset the negatives listed above.
Target saw digital channel sales increase 34% (which contributed 1.8% to comparable sales growth) and full-year adjusted earnings-per-share increase to $5.01 in fiscal 2016.
So what led to Target’s substantial price decline? It certainly isn’t in the 1.5% decreased in same store sales or the 12.7% decrease in GAAP earnings-per-share. After all, the company’s fourth quarter per-share earnings were actually in-line with management’s guidance, so investors should not have been surprised.
The reason behind Target’s price decline lies in management’s outlook for fiscal 2017. More specifically, Target’s management is expecting a substantial decline in the company’s earnings-per-share on a year-over-year basis:
“For full-year 2017, Target expects a low-single digit decline in comparable sales, and both GAAP EPS from continuing operations and Adjusted EPS of $3.80 to $4.20.”
The midpoint of this range ($4.00) represents a 20.2% decline from this year’s figure of $5.01.
As investors, it’s important to understand the dynamics behind this expected earnings decline. Here’s what the company’s CEO said about the strategic investments that Target is making to restore growth to the company.
“We will accelerate our investments in a smart network of physical and digital assets as well as our exclusive and differentiated assortment, including the launch of more than 12 new brands, representing more than $10 billion of our sales, over the next two years. In addition, we will invest in lower gross margins to ensure we are clearly and competitively priced every day. While the transition to this new model will present headwinds to our sales and profit performance in the short term, we are confident that these changes will best-position Target for continued success over the long term.” (emphasis my own)
So while Target’s management is expecting a decline in earnings-per-share, it is because they are allocating funds to areas that will ensure the company’s long-term growth.
With that in mind, let’s consider how the market’s reaction (or rather, overreaction) to Target’s earnings release has affected the company’s valuation.
The Current Value of Target’s Stock
As I write this intraday, Target is currently trading around $59. Base on the company’s $5.01 of adjusted earnings-per-share, Target is trading at a trailing price-to-earnings ratio of 11.8.
Looking ahead, the midrange of Target’s 2017 adjusted earnings-per-share guidance is $4.00, which corresponds to a forward price-to-earnings ratio of 14.8.
The following diagram shows how each of these valuations compares to Target’s historical levels.
Source: Value Line
While Target’s current valuation based on 2016’s earnings (11.8) is certainly very cheap, their forward price-to-earnings ratio (14.8) is also well below the company’s long-term average since 2000 (which is 17.5).
Even if Target fails to restore earnings growth moving forward and the company’s multiple simply expands to its long-term historical average, Target’s stock still presents 18% upside.
While waiting for Target to restore growth, investors will benefit from the company’s juicy dividend yield. Target is a Dividend Aristocrat with 46 years of consecutive dividend increases. They are also one of the highest-yielding Dividend Aristocrats at today’s prices.
The company’s last quarterly dividend was declared on January 12 to be paid on March 10 in the amount of $0.60 per share. This is equivalent to an annualized payment of $2.40 per share, which represented a yield of 4.1% based on the current ~$59 share price.
The following diagram compares how this this stacks up against Target’s long-term historical dividend yield.
Source: Sure Dividend Newsletter
Clearly, Target shareholders have been unable to capture a 4.1% dividend yield since at least the 1980s. Investors would do well to pick up these bargain shares right now and benefit from a strong dividend payment until the share price recovers.
In late November, Target was trading for $78/share. The stock is currently trading around $59, which represented a 24% decline in ~3 months.
While this has been difficult to stomach for Target’s investors, it’s important to understand that short-term fluctuations in the company’s stock price are not indicative of Target’s underlying value. In the long-run, Target will continue to do what they do best: sell affordable merchandise to the American consumer to the benefit of its long-term shareholders.
“The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table.”
– Warren Buffett
It can be extremely difficult to buy share of high-quality businesses while they are ‘on the operating table’. However, this looks to be the right move here.
Target ranked as a Top 10 Stock according to The 8 Rules of Dividend Investing last month, and it is likely to do so again in March given their appealing valuation.
Target is a buy at today’s prices.