Updated on January 23rd, 2019 by Nate Parsh
Every year, we publish a review of each of the Dividend Aristocrats, 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. With a 3.6% yield, Target is one of the highest yielding Dividend Aristocrats today.
Target also has a long history of dividend growth. The company has increased its dividend for 48 consecutive years.
Target is a unique combination of a high dividend yield, and dividend growth. And, the stock appears to be undervalued at its current price. This makes Target an attractive buy for value and dividend growth investors.
You can watch a video summary of Target’s current dividend safety below:
Target is a discount retail giant. It has a market capitalization of almost$37 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 $72 billion last year.
This is a difficult period for all of retail. The escalating threat of Internet retailers is disrupting the entire brick-and-mortar retail industry.
Target saw a 7.2% decline in earnings-per-share from 2016 to 2017, though this was below the company’s expected 20% drop. The company stated that it would need to spend in order to turn things around. The good news is, the turnaround appears to be taking shape just a year later. Target expects earnings-per-share to increase by more than 16% for 2018.
While Target has struggled in the past year, the company has done fairly well in the recent term.
The company reported third quarter results on 11/20/2018. Same-store-sales grew 5.1% during the quarter. While the company failed to meet comparable sales projections of 5.5%, Target did show fairly robust growth, especially considering that just a few years ago sales were declining or showed weak growth.
Earnings-per-share of $1.09 missed estimates by $0.02, but this total represented 20% growth from the third quarter of 2017. Revenue grew 5.6% to $17.6 billion.
Target expects to earn $5.40 in 2018, 16.1% higher than 2017’s total of $4.65. We estimate that the company can offer 6% annual earnings growth through 2023.
Target has performed better in 2018 than it did in the two previous years. Going forward, there is a good chance the company can sustain its turnaround. It has launched several initiatives to return to growth.
First, the company continues redeveloping hundreds of stores. It is modernizing layouts, and adding new product categories. By 2019, it will have revamped over 600 stores, accounting for one-third of its total store count.
Another avenue for growth is e-commerce. The rise in e-commerce initially caught many retail companies, including Target, flat footed. Target has really revamped its online offerings and has seen incredible growth rates. The most recent quarter saw digital sales grow by almost 50%, which is higher than growth rates in previous quarters (digital sales are accelerating). Digital sales boosted comparable store sales by 1.9% in its most recent quarter.
Another major growth catalyst for Target is its 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. They 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.
These improvements require significant capital expenditures, so much so that operating income decreased 3% during the third quarter. It can be argued that these costs will position Target for growth in the future. They are also likely to decrease over time.
Competitive Advantages & Recession Performance
Target operates in a difficult industry. Retail is highly competitive. For consumers, retail brands often take a back seat to price and convenience.
This is why Target has invested so heavily in store redevelopment. That has enabled the company to retain its brand strength, even in a fiercely competitive industry. 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 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 the current share price of ~$71 and the company’s adjusted earnings-per-share guidance of $5.40 for 2018, Target has a price-to-earnings ratio of just 13.1. Meanwhile, the S&P 500 Index has an average price-to-earnings ratio of 20.5.
Perhaps more importantly, the company has a 10-year average price-to-earnings ratio of 14.9. The following table illustrates Target’s average price-to-earnings ratios over the past 10 years.
If shares were to revert to their average valuation, then holders of Target’s stock would see an additional 2.6% in annual returns through 2023.
In addition, Target can generate returns from earnings growth and dividends. A breakdown of total returns is as follows:
- 6% earnings growth
- 2.6% multiple expansion
- 3.6% dividend yield
In total, Target could offer shareholders an annual return of 12.2% through 2023. This is a strong rate of return, and Target’s status as a Dividend Aristocrat and Dividend King makes it even more appealing as a dividend growth stock.
There is no question Target has struggled in recent years, but the company appears to have righted itself. Same-store-sales were up more than 5% in the third quarter. This is a healthy growth rate, particularly in a highly competitive environment for the retail industry.
Store improvements along with robust digital sales have the company positioned well for the future.
We feel that the current share price offers investors the potential for double digit annual returns over the next five years. We rate Target stock as a buy for dividend growth investors.