Ken Griffin Tremendously Upped Stake in Target Corp.

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Jun 15, 2015

In this article, let's take a look at one important holding of Ken Griffin´s Citadel Investment Group, Target Corp. (TGT, Financial), the $50.74 billion market cap company, which has recently announced a dividend hike.

The fund disclosed holding 4.37 million Target shares, up by 799% on the quarter, with the value of the stake amounting to $359.02 million. Furthermore, the stock returned 8.1% in the quarter.

7.7% dividend hike

The firm has an attractive dividend policy showing its commitment to return cash to investors in the form of dividends as it generates healthy cash flow on a regular basis. According to company reports, dividends have been paid since 1965.

On June 10, TGT announced a 7.7% increase in its quarterly dividend to $0.56 from $0.52 per share, which will generate an annualized dividend of $2.24 per share. With a closing price of $79.47 it now offers an annualized dividend yield of 2.80%.

Moreover, Target is doubling its share buyback program to $10 billion, which allows the company to invest in itself, reducing the number of shares outstanding on the market.

So now, let´s use all the information to try to find the intrinsic value of the stock.

Calculation of intrinsic value

In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends according to John Burr Williams.

Although this is theoretically correct, it requires forecasting dividends for many periods, so we can use some growth models like: Gordon (constant) growth model, the Two or Three stage growth model or the H-Model (which is a special case of a two-stage model).With the appropriate model, we can forecast dividends up to the end of the investment horizon where we no longer have confidence in the forecasts and then forecast a terminal value based on some other method, such as a multiple of book value or earnings.

To start with, the Gordon Growth Model (GGM) assumes that dividends increase at a constant rate indefinitely.

This formula condenses to: V0=(D0 (1+g))/(r-g)=D1/(r-g)

where:

V0 = fundamental value

D0 = last year dividends per share of Exxon's common stock

r = required rate of return on the common stock

g = dividend growth rate

Let´s estimate the inputs for modeling:

Required rate of return (r)

The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stockj = risk-free rate + beta of j x equity risk premium

Assumptions:

Risk-Free Rate: Rate of return on LT Government Debt: RF = 2.75%[1]. This is a very low rate because of today´s context. Since 1900, yields have ranged from a little less than 2% to 15%; with an average rate of 4.9%. So, I think it is more appropriate to use this rate.

Beta: β =0.91[2]

GGM equity risk premium = (1-year forecasted dividend yield on market index) +(consensus long-term earnings growth rate) – (long-term government bond yield) = 2.13% + 11.97% - 2.67% = 11.43%[3]

rTGT = RF + βTGT [GGM ERP] = 4.9% + 1.29 [11.43%]= 15.30%

Dividend growth rate (g)

The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm´s debt-to-equity ratio is unchanged and it doesn´t issue new equity.

g = b x ROE

b = retention rate

ROE=(Net Income)/Equity= ((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)

The “PRAT” Model:

g= ((Net Income-Dividends)/(Net Income)).((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)

Let´s collect the information[4] we need to get the dividend growth rate:

Financial Data (USD $ in millions) January 31, 2015 February 1, 2014 February 2, 2013
Cash dividends declared (1,205,000) (1,006,000) (869,000)
Net income applicable to common shares (1,636,000) 1,971,000 2,999,000
Net sales 72,618,000 71,279,000 73,301,000
Total assets 41,404,000 44,553,000 48,163,000
Total Shareholders' equity 13,997,000 16,231,000 16,558,000
Ratios   Â
Retention rate 0 1.51 1.29
Profit margin -0.02 0.03 0.04
Asset turnover 1.75 1.60 1.52
Financial leverage 2.74 2.72 2.97
   Â
Retention rate = (Net Income – Cash dividends declared) ÷ Net Income = 0.26
   Â
Profit margin = Net Income ÷ Net sales = -0.02 Â Â
   Â
Asset turnover = Net sales ÷ Total assets = 1.75 Â Â
   Â
Financial leverage = Total assets ÷ Total Shareholders' equity = 2.96 Â
   Â
Averages   Â
Retention rate 1.02 Â Â
Profit margin 0.02 Â Â
Asset turnover 1.63 Â Â
Financial leverage 2.81 Â Â
   Â
g = Retention rate × Profit margin × Asset turnover × Financial leverage Â
   Â
Dividend growth rate 7.16% Â Â
   Â

Because for most companies, the GGM is unrealistic, let´s consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage, until it reverts to the long-run rate. A smoother transition to the mature phase growth rate that is more realistic.

Dividend growth rate (g) implied by Gordon growth model (long-run rate)

With the GGM formula and simple math:

g = (P0.r - D0)/(P0+D0)

= ($79.47 × 15.30% – $2.24) ÷ ($79.46 + $2.24) = 12.14%.

The growth rates are:

Year Value g(t)
1 g(1) 7.16%
2 g(2) 8.40%
3 g(3) 9.65%
4 g(4) 10.89%
5 g(5) 12.14%

G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).

Intrinsic Value

Year Value Cash Flow Present value
0 Div 0 2.24 Â
1 Div 1 2.40 2.082
2 Div 2 2.60 1.957
3 Div 3 2.85 1.861
4 Div 4 3.16 1.790
5 Div 5 3.55 1.741
5 Terminal Value 125.88 61.771
Intrinsic value   71.20
Current share price   79.47

Final comment

We found that intrinsic value is above the trading price, so we can conclude that the stock is fairly valued. If you trust in the model and assumptions, I would recommend holding this stock in your portfolios. This conclusion is based on the use of a margin of safety, which means that an investor should buy a stock when it is worth more than its price on the market plus a margin (more or less 20% is used). In this case, the difference is 11%. The stock has a consensus analyst price target of $80.90, which means an actual potential upside of almost 2%.

We have covered just one valuation method and investors should not be relied on alone in order to determine a fair (over/under) value for a potential investment.

Several investors reported long positions in the stock, including Joel Greenblatt (Trades, Portfolio)’s Gotham Asset Management, which own 708.187 shares and 58.12 million shares.

Disclosure: Omar Venerio holds no position in any stocks mentioned.


[1] This value was obtained from the U.S. Department of the Treasury

[2] This value was obtained from Yahoo Finance.

[3] These values were obtained from Bloomberg´s CRP function.

[4] These values were obtained from Yahoo! Finance.