Discount retailer Target Corporation (TGT, Financial) has performed very well recently, with the stock gaining 31% year-to-date, 90% over the last year and 240% over the last five years.
A sizeable portion of this return has been supported by heightened demand related to the Covid-19 pandemic. Target, like many retailers, has enjoyed excellent same-store sales growth as consumers stocked up on everyday items.
While the stock is trading with a higher than usual multiple, Target is far from overly expensive relative to its expected growth rate, in my opinion.
A rundown of earnings
Target announced its first-quarter earnings results on May 19. Revenue grew 23.4% year-over-year to $24.2 billion, crushing Wall Street analysts’ estimates by more than $2 billion. Excluding a 53-cent benefit from the sale of Dermstore, Target’s adjusted earnings per share of $3.69 compared favorably to adjusted earnings per share of 59 cents in the same period of the prior year, delivering a $1.46 beat of expectations.
Same-store sales surged 22.9% during the quarter, easily coming in ahead of consensus estimates of 10.7%. The two-year stack rate for same-store sales is 33.7%. Target said it experienced traffic growth of 17%, while the average basket size increased 5%.
Digital sales were up more than 50% year-over-year and accounted for 18.3% of total company sales. Target’s order pickup, drive up and ship from store growth nearly doubled, with drive up posting a 123% increase from last year. Shipt growth was also very strong at 86% and order pickup was higher by 52%.
The gross margin continued to improve, reaching 30% in the first-quarter, which is a 490 basis point improvement from the previous year. Target isn’t marking down as much of its merchandize, which has allowed gross margin to improve as much as it did. Analysts had expected a gross margin of 28.6%.
Target’s balance sheet paints a picture of a company in excellent financial shape. The company had total assets of $50.5 billion, including current assets of $19.9 billion and cash and equivalents of $7.8 billion at quarter’s end. Inventory of $10.5 billion was up 23% from a year ago, but down fractionally sequentially. With demand as high as it is, maintaining current levels of inventory appears to be a prudent move. It’s also a positive that the company has higher inventories year-over-year and yet Target has refrained from having to discount merchandize in order to move it. Comparable sales growth shows that discounts haven’t been needed as consumers have seemingly accepted paying regular prices.
Total liabilities came in at $35.5 billion, including current liabilities of $18.6 billion. Much of the current liabilities are in the form of payables and accrued expenses. Long-term debt was just over $15 billion, but just $1.2 billion of debt matures within the next year. The company also generated free cash flow of $2.8 billion during the quarter and $7.9 billion over the last four quarters.
Guidance
Target provided some guidance for the remainder of the year. Leadership stated that the operating margin could approach 8% in 2021, topping last year’s 7%. Same-store sales are also expected to be up at least mid-single digits in the second-quarter and positive for the last two quarters of the year. The company posted comparable sales of 10.9%, 11.2% and 20.5% over the last three quarters of 2020, respectively, so the two-year stack rates are likely going to be solid for the remainder of the year.
Wall Street analysts expect earnings per share of $12.23 for 2021, which would be a 30% improvement from 2020 and almost double what the company produced in 2019. Analysts don’t exactly think that that this year will be an on-off scenario either as estimates call for earnings per share of $11.95 in 2022. If the company achieves analysts’ estimates for both periods, then 2021 and 2022 would be the most successful years, in terms of earnings per share, in Target’s history, which dates bates to 1902.
Takeaways and valuation
Target did benefit from easy comparable numbers given the weakness it experienced at the beginning of the spread of Covid-19 in the U.S., but the company easily beat already elevated analyst expectations for the first-quarter. Same-store sales were more than double that of consensus estimates, showing that demand for the company’s offerings remains at high levels.
Digital channels remain robust as Target saw a drastic increase in this area. The fact that digital continues to enjoy high growth rates is impressive given that this channel contributes a meaningful percentage to total sales.
Same-day orders continue to be in growth mode and don’t show many signs of slowing down. Keep in mind that same-day services were up 278% in the first-quarter of last year, so this past quarter’s results aren’t exactly off a low base. The story is the same for the other same-day services. Shipt posted 300% growth and order pickup doubled in the same period of 2020. The growth that these two services had was on top of the excellent gains that were made in the previous year.
Same-day sales accounted for just over half of all digital sales. This is important as this means that nearly 10% of Target’s total sales came from same-day services, many of which didn’t exist prior to the appearance of Covid-19 or were just a small part of the company’s business.
Omnichannel gains have allowed Target to capture market share over the last year, with leadership estimating that the company had $1 billion of market share gains during the quarter on top of the $1 billion it captured last year. Even with more stores opened in the first-quarter, Target accelerated its growth in market share, a feat that few, if any, other retailers have accomplished.
Consumers aren’t just coming to Target stores for food and toilet paper either. Apparel sales were up more than 60% while home and hardlines categories each grew at least 30% compared to last year. Beauty experienced a high teens improvement. Essentials and food and beverage, which were two of the best categories last year, both showed low single-digit sales growth.
Target closed the June 7 trading day at $231, resulting in a forward price-earnings ratio of 18.9. Target had an average price-earnings ratio of 14.5 over the past five years and 15 over the last decade.
Final thoughts
Target continues to deliver excellent results even as comparable numbers start to get tougher. The two year-stack rates for same-store sales neared 34% for the first-quarter as the company saw an explosion in same-day services, store traffic and basket sizes. What investors should find especially attractive is the growth of same-day services on top of last year’s activity. Digital also makes up a non-trivial number of total sales and several of these channels barely existed, if at all, prior to the onset of the Covid-19 pandemic.
Target weathered the pandemic storm very well and has come out the other side in a position of strength. The company also has a long history of raising its dividends. Though shares yield just 1.2% at the moment, Target has raised its dividend for 53 consecutive years, one of just 30 or so companies with at least five decades of dividend growth.
Compared to the intermediate or long-term valuation, Target can be deemed overvalued as currently priced. That said, I think Target’s expected growth rates justify the valuation. If the name wasn’t the largest position in my portfolio, I would be a buyer of Target even at this price.
Author disclosure: the author maintains a long position in Target Corporation.
