(Published Feb. 28 by Nicholas McCullum)
Target Corp. (TGT, Financial) investors have seen the company’s stock go through a prolonged downturn over recent months. Unfortunately, this trend appears to be continuing.
On Feb. 28, Target reported earnings that seriously disappointed. The stock fell from $67 to $57.50 and currently sits around $59.
Source: Yahoo! Finance
It is important to remember Target’s stock price is not necessarily indicative of the company’s actual per-share value.
Sometimes, stock prices become irrationally disconnected from the value of the underlying business. This is a good thing for opportunistic investors.
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” – Warren Buffett (Trades, Portfolio)
It is important to remember Target is a high-quality business with a strong history of rewarding shareholders. Target has raised its annual dividend payments for 46 consecutive years, which makes it a member of the elite Dividend Aristocrats (companies with 25-plus years of rising dividends).
You can see the list of all 51 Dividend Aristocrats here.
Rather than being a cause for concern among investors, Target’s decline presents a buying opportunity.
Breaking down the earnings release
Upon initial perusal, Target’s earnings report seems fine. Here are a few of the company’s key metrics from the press release:
- Fourth-quarter comparable sales decreased 1.5%, compared to the guidance range of 1.5% to 1.0%.
- Fourth-quarter comparable digital channel sales increased 34%, contributing 1.8 percentage points of comparable sales growth.
- Fourth-quarter GAAP earnings per share (EPS) from continuing operations of $1.46 and Adjusted EPS of $1.45, compared with the Company’s guidance range of $1.45 to $1.55.
- For full-year 2016, GAAP EPS from continuing operations declined 12.7% to $4.58, reflecting a loss of 44 cents on the early retirement of debt.
- Full-year Adjusted EPS increased 6.7% to $5.01.
There are a few things to cause concern – most notably declining same-stores sales and a reduction in GAAP EPS.
There are also a few bright spots from this earnings release which arguably offset the negatives listed above.
Target saw digital channel sales increase 34% (which contributed 1.8% to comparable sales growth) and full-year adjusted EPS increase to $5.01 in fiscal 2016.
So what led to Target’s substantial price decline? It certainly is not in the 1.5% decrease in same-store sales or the 12.7% decrease in GAAP EPS. After all, the company’s fourth-quarter per-share earnings were actually in line with management’s guidance, so investors should not have been surprised.
The reason behind Target’s price decline lies in management’s outlook for fiscal 2017. More specifically, Target’s management is expecting a substantial decline in the company’s EPS on a year-over-year basis:
“For full-year 2017, Target expects a low single-digit decline in comparable sales, and both GAAP EPS from continuing operations and Adjusted EPS of $3.80 to $4.20.”
The midpoint of this range ($4) represents a 20.2% decline from this year’s figure of $5.01.
As investors, it is important to understand the dynamics behind this expected earnings decline. Here is what the company’s CEO, Brian Cornell, said about the strategic investments Target is making to restore growth.
“We will accelerate our investments in a smart network of physical and digital assets as well as our exclusive and differentiated assortment, including the launch of more than 12 new brands, representing more than $10 billion of our sales, over the next two years," Cornell said. "In addition, we will invest in lower gross margins to ensure we are clearly and competitively priced every day. While the transition to this new model will present headwinds to our sales and profit performance in the short term, we are confident that these changes will best position Target for continued success over the long term.” (emphasis my own)
So while Target’s management is expecting a decline in earnings per share, it is because they are allocating funds to areas that will ensure the company’s long-term growth.
With that in mind, let’s consider how the market’s reaction (or rather, overreaction) to Target’s earnings release has affected the company’s valuation.
The current value of Target’s stock
As I write this intraday, Target is currently trading around $59. Base on the company’s $5.01 of adjusted EPS, Target is trading at a trailing price-earnings (P/E) ratio of 11.8.
Looking ahead, the midrange of Target’s 2017 adjusted EPS guidance is $4, which corresponds to a forward P/E ratio of 14.8.
The following diagram shows how each of these valuations compare to Target’s historical levels.
Source: Value Line
While Target’s current valuation based on 2016’s earnings (11.8) is certainly very cheap, the forward P/E ratio (14.8) is also well below the company’s long-term average since 2000 (which is 17.5).
Even if Target fails to restore earnings growth moving forward and the company’s multiple simply expands to its long-term historical average, Target’s stock still presents 18% upside.
While waiting for Target to restore growth, investors will benefit from the company’s juicy dividend yield. Target is a Dividend Aristocrat with 46 years of consecutive dividend increases. They are also one of the highest-yielding Dividend Aristocrats at today’s prices.
The company’s last quarterly dividend was declared on Jan. 12 to be paid on March 10 in the amount of 60 cents per share. This is equivalent to an annualized payment of $2.40 per share, which represents a yield of 4.1% based on the current approximate $59 share price.
The following diagram compares how this stacks up against Target’s long-term historical dividend yield.
Source: Sure Dividend Newsletter
Clearly, Target shareholders have been unable to capture a 4.1% dividend yield since at least the 1980s. Investors would do well to pick up these bargain shares right now and benefit from a strong dividend payment until the share price recovers.
Final thoughts
In late November, Target was trading for $78 per share. The stock is currently trading around $59, which represents a 24% decline in about three months.
While this has been difficult to stomach for Target’s investors, it is important to understand short-term fluctuations in the company’s stock price are not indicative of the companys underlying value. In the long run, Target will continue to do what it does best: sell affordable merchandise to the American consumer at the benefit of its long-term shareholders.
“The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table.”
– Warren Buffett (Trades, Portfolio)
It can be extremely difficult to buy shares of high-quality businesses while they are "on the operating table." However, this looks to be the right move here.
Target ranked as a Top 10 Stock according to The 8 Rules of Dividend Investing last month, and it is likely to do so again in March given its appealing valuation.
Target is a buy at today’s prices.
Disclosure: I am long TGT.
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