Target (TGT, Financial) is the third-largest discount retailer in the United States based on market cap, behind only Walmart (WMT, Financial) and Costco (COST, Financial).
The company was founded in 1902 and has paid increasing dividends for 48 consecutive years.
Target’s former CEO Gregg Steinhafel – and Target shareholders – did not have a good run in 2013 and 2014. Steinhafel oversaw Target’s expansion into Canada. The company lost $2 billion in two years in Canada.
The Canadian expansion was plagued by poor execution, stocking issues and higher-than-expected prices.
In addition to the Canada debacle, Target also had a massive data breach at the end of 2013 which compromised around 40 million customer Target credit card numbers. The breach could cost Target upwards of $500 million after accounting for card reissuance costs and settlements.
Steinhafel was replaced in 2014 by Brian Cornell. Cornell is the first CEO hired from outside of Target in the company’s history. Cornell’s impressive resume is as follows:
- Executive vice president and chief marketing officer of Safeway (SWY, Financial) from 2004 to 2007
- CEO of Michaels (MIK, Financial) from 2007 to 2009
- CEO of Sam’s Club from 2009 to 2012
- CEO of PepsiCo (PEP, Financial) Americas Foods division from 2012 to 2014
At Safeway, earnings per share grew from $1.25 in 2004 to $1.99 in 2007 while Cornell held a senior management position. Of course, it is very difficult to say if strong growth over that period is directly attributed to him or not.
Cornell left Safeway to become CEO of Michaels. The company was owned by three private equity groups at the time, so results are not publicly available.
Cornell must have done well at Michaels, as Walmart hired him to run Sam’s Club in 2009. Cornell boosted operating income at Sam’s Club from $1.5 billion to $2 billion in his tenure there – a compound growth rate of 10.1% a year.
PepsiCo’s operating structure changed under Cornell’s time there, making comparisons difficult.
Target’s new CEO quickly made a positive impression by announcing the company would sell its Canada operations. This move will be beneficial for Target shareholders over the long run. It focuses the company’s operations, advertising spending and management on its lucrative U.S. operations.
The company continues to divest noncore operations and focus on its strengths of quality merchandise at low prices.
Target recently struck a deal with CVS Health (CVS, Financial). In the deal, Target will sell all its pharmacy operations to CVS Health for $1.9 billion (approximately $1.2 billion after tax). CVS Health will rebrand and run all of Target’s in-store pharmaceutical operations.
The deal further focuses Target on providing low cost, quality merchandise to its customers while outsourcing what it doesn’t do best. Cornell had this to say about the deal:
“By partnering with CVS Health, we will offer our guests industry-leading health care services, and at the same time, sharpen our focus on elevating the way we deliver wellness products and experiences to our guests.”
The bulk of funds from the CVS Health deal are expected to be uses for share repurchases.
Competitive advantage
Target’s long dividend streak and over a century of company growth show evidence of a strong and durable competitive advantage.
Target’s competitive advantage is a blend of low pricing and a clean, friendly shopping experience.
While Target’s prices are low, they are not lower than its rivals. The company’s main rival is Walmart. A recent study shows that Walmart costs about 3% less than Target.
This should be expected, as Target does not have the same scale and purchasing power as Walmart. Walmart generates more than six times the amount of sales as Target. Click here to see why Walmart’s stock price recently plunged.
Despite its small price disadvantage against its largest competitor, Target attracts a wide audience. Target stores have a cleaner feel than competitors like Walmart, Family Dollar (FDO, Financial) and other discount retail dollar stores. While difficult to quantify, the general branding and feel of Target stores has allowed the company to compete with its larger rival.
Target’s management team is focused on bringing fashionable and in-style merchandise to its stores that appeals to a wide range of consumers.
Growth prospects
Target has compounded earnings per share at 5.2% a year over the last decade. The company’s growth would have been significantly faster if management decided not to pursue expansion into Canada and instead used cash from that operation for growth in the United States and share repurchases.
Fortunately, Target is now on the right track. From 2003 to 2012 (before significant Canada expenditures botched growth), Target grew earnings per share at 9.0% a year.
Target should be able to continue growing its earnings per share around 7% to 9% a year over the next several years as long as the company remains focused on incrementally growing U.S. offerings.
In addition to earnings-per-share growth, Target currently offers investors a dividend yield of 3%. This yield combined with expected growth gives investors solid expected total returns of 10% to 12% a year going forward.
Recession performance
Target’s underlying business does not lose much ground during recessions because it is a discount retailer. Consumers still must buy food products and other household goods during times of economic hardship. Target is one of the cheaper retailers to purchase these items, giving it a constant stream of customers in both economic expansions and declines.
The company’s earnings per share over the Great Recession of 2007 to 2009, and subsequent recovery are shown below to illustrate this point:
- 2007 earnings per share of $3.33 (new high)
- 2008 earnings per share of $2.86 (14% decline off high)
- 2009 earnings per share of $3.30 (1% decline off high)
- 2010 earnings per share of $3.88 (new high)
As you can see, Target held up well through the Great Recession. The company’s strength through all economic conditions gives dividend investors little risk of a dividend cut.
Valuation and final thoughts
Target currently has a price-to-earnings ratio of 19.1 (using adjusted earnings). Over the last decade, the company’s average price-to-earnings ratio was 15.8.
Based on its historical price-to-earnings ratio, Target is trading above fair value. The company is trading around fair value based on its solid expected total returns, competitive advantage and resistance to recessions.
Overall, now is not the best time to buy shares of Target based on how much the company’s price-to-earnings ratio has appreciated versus historical averages.
