Target is one of the largest retailers in North America. It has nearly 1,800 unit stores that offer general merchandise and now food products. The vast majority of the stores are located in the U.S., although Target has made great efforts to start operating in Canada.
Twenty percent of the general merchandise is sold under private label. The firm has also been expanding its Internet presence and has issued its own credit card, REDcard, which offers customers a 5% discount on purchases made with the card.
Generally speaking, Target has been facing certain headwinds. The return on invested capital will probably decline with the firm’s transition of a large portion of assets to the lower-return food business, PFresh.
This is an initiative similar to that of Walmart (NYSE:WMT). However, PFresh will not obtain the same results. Walmart has been able to capture the excess profits from the grocery business.
Management is intending to sell the credit card receivables market in the near future. This will cause a decline in operating margins and returns. Furthermore, the store ramp-up in Canada will also impact cash flows negatively.
Fortunately shares are fully valued as it transitions to a grocery store. This new strategy will lower returns in the first place, but they will re-accelerate again with the passing of time.
Management anticipates that the increase in customer traffic will yield incremental sales in the general merchandise categories, which carry much higher margins than groceries.
Although this general view of the company is not stunning, there are some reasons to buy a position in it. These are the most important ones:
- The company’s efficient marketing, the multi-channel strategy, a product innovation, compelling pricing, among other issues help to increase sales and operating margins.
- With time, Target will start to focus on store renovations and on improving sales productivity.
- Just like Wal-Mart, Target is planning to set up smaller stores to catch the urban markets while real estate remains constraint.
- Target is analyzing opening stores overseas, in places such as Canada and Latin America. These stores will definitely boost the company returns and increase cash flow.
- As regards cash flow, the company is managing them actively. Target has always been focused on enhancing shareholders returns through a dividend increase and repurchase programs.
It is logical that good things always have their shadow. Target may also face certain headwinds in the market.
- Competition is fierce and Target may face it as to discount and department stores, drug stores, supermarkets, and other forms of retail commerce.
- The credit markets are under disruption, therefore obtaining financing may be somehow difficult. This may increase borrowing costs and reduce the ability to obtain additional financing.
- Customers remain sensitive to macroeconomic factors and this may negatively impact on Target.
The company reported operating margin expansion of 20 basis points, from 6.2% to 6.4%.
This expansion was mainly driven by the credit card segment. It seems that despite the good performance, Target is thinking of selling it.
The company has also reported earnings per share of $0.82 and monthly store sales of 4.3%.
Although the gross margin contracted 18 basis points in the retail segment, this was offset by 41 basis points expense leverage off a solid comp.
Management is making the right decision in terms of strategy by deploying a much higher degree to food.
Target's president and CEO, Gregg Steinhafel, has experience in the industry, as do the directors.
What really calls attention to management is its openness to shareholders proposals.
The expectations for the future are good. The fair value estimate is $58 per share, which involves multiples of 13.3 and 6.9 times on P/E and value/EBITDA respectively.
Despite the fall of ROIC on average, it will remain above the 9% weighted average cost of capital.