Dividend Aristocrats In Focus Part 18: Target

Updated on November 25th, 2019 by Nate Parsh

Every year, we publish a review of each of the Dividend Aristocrats , group of 57 companies in the S&P 500 Index with 25+ consecutive years of dividend increases.

In addition to the full downloadable spreadsheet, you can see a preview of the Dividend Aristocrats list in the table below:

Next up on our list of Dividend Aristocrats is Target Corporation (TGT).

Target has a long history of dividend growth. The company has increased its dividend for 48 consecutive years. Two more years of dividend growth will qualify Target as a Dividend King, an even more exclusive list of companies that have increased dividends for at least 50 consecutive years.

Target has one of the best performing names in the entire market this year. Shares have returned more than 91% year-to-date. Following this, we believe that investors should find recent results attractive and be prepared to buy the stock on a pullback.

Business Overview

Target is a discount retail giant. It has a market capitalization in excess of $64 billion. Today, it operates approximately 1,850 stores in the U.S., as well as an e-commerce business. It has a diverse product lineup, with sales of more than $75 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 seems to have already occurred. More importantly, Target appears to have entered into a new growth phase. Target expects earnings-per-share to increase by 18% for 2019, following a 16% improvement last year. This is quite the opposite of the company’s performance just a few years ago.

The company reported third quarter results on 11/20/2019. Same-store-sales grew 4.5% during the quarter, higher than consensus estimates of 3.5%. Target continues to show fairly robust growth, especially considering that just a few years ago sales were declining or showed weak growth.

The company’s third quarter earnings-per-share grew 25% to $1.36, beating estimates by $0.17. Revenue grew 4.7% to $18.7 billion.

Target expects to earn between $6.25 to $6.45 in 2019. We estimate that the company can offer 6% annual earnings growth through 2024 due to improvements in business fundamentals.

Growth Prospects

Target performed better in 2018 and 2019 than it did in the two previous years. Going forward, there is a good chance the company can sustain its turnaround, because it has launched several initiatives to return to growth.

First, Target has invested heavily in 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 31%, a decline from last year’s 49% growth, but still an impressive result. Digital sales accounted for 7.5% of total sales in the quarter. Digital sales boosted comparable store sales by 1.9% in its most recent quarter.

Target has also rolled out its same-day fulfillment service. This service contributed 80% of Target’s digital comparable sales growth in the third quarter.

Next, the company continues redeveloping hundreds of stores. It is modernizing layouts, and adding new product categories. By the end of 2019, it will have revamped over 600 stores, accounting for one-third of its total store count.

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. .

These improvements require significant capital expenditures. Capital expenditures have more than doubled over the past few years, but it can be argued that these costs will position Target for growth in the future. Despite this, operating income improved more than 22% in the most recent quarter, operating margins improved 80 bps and gross margins increased 110 bps to 29.8%.

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

Due to the returns in share price this year, Target’s valuation has reached heights not seen very often over the last decade. Based on the current share price of $127 and the company’s adjusted earnings-per-share guidance of $6.35 for 2019, Target has a price-to-earnings ratio of 20. Meanwhile, the S&P 500 Index has an average price-to-earnings ratio of 23.

Perhaps more importantly, the company has a 10-year average price-to-earnings ratio of 15. If shares were to revert to their average price-to-earnings ratio, then holders of Target’s stock would see annual returns reduced by 5.6% over the next five years due to valuation.

In addition, Target can generate returns from earnings growth and dividends. A breakdown of total returns is as follows:

• 6% earnings growth
• 5.6% multiple reversion
• 2.1% dividend yield

In total, Target could offer shareholders an annual return of 2.5% through 2024. This is a low rate of
return, but not surprising given how well the stock has done since the start of the year.

Final Thoughts

There is no question Target had struggled dealing with the rise of e-commerce shopping along with the rest of retail, but the company appears to have righted itself and growth has returned. Same-store-sales were higher than expected and digital sales continue to impress given the highly competitive environment for the retail industry. Store improvements have also led to an increase in customer traffic.

However, we feel that the current valuation is too rich. In a way, Target is a victim of its own success–the massive rally in share price over the past year has pushed the valuation well above our fair value estimate. As such, we rate shares as a hold and encourage investors to wait for a pullback before buying stock in Target.