Target: Can Continued Growth Outweigh Valuation Concerns?
The stock market can be a very fickle place. This is due, primarily, to the fact that human sentiment (which is often irrational) tends to drive share price movement in the short-term. Only after longer periods of time, do the underlying fundamentals of companies begin to shine through and dictate value.
The short sightedness with which the market operates can lead to tremendous opportunities for investors who are willing to go against the grain and play the contrarian role. Turnaround stories have the potential to create some of the best returns in the entire market. Buying out of favor companies and patiently waiting for mean reversion to occur is how value investors make a living. And, one of the best examples of such a trade that we’ve seen in recent years is the decline and ensuing bounce back that has occurred with Target (TGT) shares during the past several years.
In June of 2017, Target shares were trading for just 10.5x earnings and had a dividend yield in the 4% area. TGT shares were unloved by the market because of a belief that the rise of eCommerce would make traditional big-box stores obsolete. The company was being priced as if they were going to produce zero growth over the long-term. Well, those 2017 projections couldn’t have been farther from the truth.
While it’s true that Target produced negative 6% earnings-per-share growth in 2018 as management invested heavily in new store formats, logistical infrastructure, and omni-channel related technology, since then, we’ve seen the company generate reliable top and bottom-line growth.
In 2017, Target generated $70.27 billion in revenue. In fiscal 2021 (which ended In January for Target), the company’s annual sales had grown to $93.56 billion. In short, the company’s investments have paid off handsomely.
Jeremy Bowman, a Nobias 4-star rated analyst who writes for The Motley Fool, highlighted the productivity of Target’s recent investments in a recent article, saying, “Though Target may be best known for its brick-and-mortar stores, the company has invested billions in its e-commerce infrastructure to move closer to a hybrid, omnichannel model.”
He continued, saying, “Stores fulfill nearly all of Target's sales, including those that take place online. In the first quarter, stores fulfilled 96.3% of the company's sales, even though only 81.7% of its sales originated in its stores. That strategy of using its stores to fulfill online orders has made Target much more profitable than its closest peers, including Walmart, Costco, and Amazon's e-commerce division.”
During its last fiscal year, Target’s profit focused business model generated 47% earnings-per-share growth. And, with profits booming, the market has taken notice. The company which was once trading in the bargain bin with a near-single digit price-to-earnings ratio now trades for 21.99x blended earnings. This multiple is well above TGT’s historical 17.6x long-term (20-year) average. It’s also well above the company’s 5 and 10-year average P/E multiples of 14.99x and 15.05x, respectively.
Year-to-date, TGT shares have risen by 27.5%, beating the broader market by a wide margin. Over the past year, TGT shares are up 89.66%, showing a strong bounce off of the COVID-19 lows. So, while it’s obvious that Target has been on a roll, investors who’re thinking about buying shares today have to contend with what appears to be an abnormally high valuation. And, with that in mind, we wanted to check in with the analysts who’re 4 and 5-stars by the Nobias algorithm to see what they’ve had to say in the wake of Target’s recent first quarter earnings report.
Jennifer Saibil, a Nobias 4-star rated analyst who writes for The Motley Fool, recently published an article where she wrote, “To fortify your holdings, you should consider diversifying your portfolio by adding stocks that can perform well in any type of market. If I had to choose one unstoppable stock that has the potential to do well even during a market crash, I would buy shares of Target.” Saibil noted that during 2020, Target outperformed other popular large cap retail investments, such as Wal-Mart (WMT) and Costco (COST), saying, “Fiscal 2020 comps generated 19% growth year over year, driven in part by a ramp-up of same-day services, which saw a 235% increase in use.” While she admits that it’s going to be difficult for Target to post those types of growth figures year in and year out, Saibil is bullish on Target, especially relative to its retail peers, because of two primary reasons. She says, “The first of these differences, or competitive advantages, is Target's well-rounded business model, which comprises Super-sized stores, small-format stores, and omnichannel options.”
Most people probably think of Target through a big-box retail lens, imaging the 100,000 square foot stores that retail became famous for prior to the rise of eCommerce. Target has plenty of these still in operation; however, Saibil likes the company’s new smaller footprint stores that the company has been building in recent years. She says that the company has built 140 of these smaller footprint stores, which can be as little as 12,000 square feet. She says, “Each store offers a tailored product line that fits the needs of its community, such as its 30 small-format stores near college campuses that offer a selection of products geared toward college students. These stores also serve as shipping hubs for the surrounding region and make delivery cheaper and faster.”
Saibil also believes that Target’s store brands differentiate it from its peers, saying, “The other competitive advantage is Target's owned brands. Target owns 48 exclusive brands, 10 of which generated at least $1 billion in 2020 sales, and four of which generated at least $2 billion. Altogether, they represent a third of total sales, which is significant.”
Nicholas Ward is a Senior Investment Analyst at Wide Moat Research. He has spent the last 8 years writing about the stock market at various publications, including Seeking Alpha, The Street, Forbes Real Estate Investor, Sure Dividend, The Dividend Kings, iREIT, Safe High Yield, and The Intelligent Dividend Investor.
Gabriela Barkho, another Nobias 4-star rated analyst who writes for Modern Retail, also highlighted Target’s private label brand success in a recent article, saying that during Q1, “The company added that private label lines were also a major driver of sales, reaching a record 36% in sales growth.” In Barkho’s piece, she highlighted a quote by Target’s Chief Growth Officer, Christina Hennington, who highlighted the success of the store owned brands, saying, “These brands aren’t something that our guests pick up while they’re at Target, they’re a big reason why they shop at Target, which is why we continue to invest in them.”
Barkho noted that Target’s store-owned brands don’t just reside in the apparel segment either. She said, “Expanding its private label assortment in grocery has been a big focus for Target. In April, it introduced a new line called Favorite Day, which features 700 products across snacks and frozen desserts. Target is also expanding its Good & Gather line, a grocery private label line introduced in 2019, by adding more plant-based products to it.”
Barkho also mentioned the recent success of the company’s Mondo Llama brand, which management launched to capitalize on the increased interest in crafting, as well as the company’s Opalhouse brand, which focuses on home decor, which have both been bit hits during the stay-at-home trend seen throughout the COVID-19 pandemic. So, even after all of the success that TGT shares have had recently, we see that blue chip Nobias analysts remain largely bullish on the company.
Of the reports posted by 4 and 5-star analysts since the company’s first quarter earnings last week, we see 6 “Buy” ratings and just 1 “Sell” rating. With that in mind, it’s clear that the analyst community believes that the company’s growth prospects outweigh the stock’s valuation concerns and expect to see more blue skies ahead for this big box retailer.
Disclosure: Nicholas Ward is long AMZN. Nicholas Ward wrote this article for Nobias at their request with a view of giving investors a balanced perspective based on the writings of Nobias highly rated analysts and bloggers. Nobias has no business relationship with any company whose stock is mentioned in this article and does not have a position in this stock.
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