(Published March 7 by Bob Ciura)
Discount retail giants Walmart Stores (WMT) and Target (TGT, Financial) are both on the list of Dividend Aristocrats.
The Dividend Aristocrats are a group of 51 companies in the Standard & Poor's 500 with 25-plus years of consecutive dividend increases.
You can see the full Dividend Aristocrats List here.
Walmart and Target have raised their dividends for 44 and 45 years in a row.
With such long histories of steady increases, they have proven they can navigate the ups and downs of the retail industry.
This is an especially challenging period for both Walmart and Target. Their core brick-and-mortar business models are under fire from e-commerce sites like Amazon.com (AMZN).
Walmart and Target are working hard to catch up in e-commerce while continuing to reward shareholders with steady dividend raises.
Even though it might sound crazy, Walmart’s quicker turnaround actually makes Target the better investment right now.
Business overview
Winner: Walmart
Walmart has an edge over Target because it is more diversified. Walmart operates more than 11,000 stores, both in the U.S. and in the international markets.
Target operates exclusively in the U.S., after closing its stores in Canada.
In addition, Walmart owns a warehouse club under the Sam’s Club banner.
Walmart is organized into three operating segments:
- Walmart U.S. (64% of sales).
- Walmart International (24% of sales).
- Sam’s Club (12% of sales).
Walmart’s international business provides it with an advantage over Target because it opens up new avenues for growth.
Source: 4Q Presentation, page 9
Walmart saw strong growth in Canada, Mexico and Brazil in the fourth quarter.
Excluding the impact of foreign exchange, Walmart’s international segment grew net sales, and operating profit rose 3.0% and 3.8%Â last fiscal year.
Ten of Walmart’s 11 international markets posted positive comparable sales last year, seven of which grew comparable sales by more than 4%.
Target’s concentration in the U.S. has provided it with a nationwide footprint consisting of 1,800 stores.
Source: 4Q Earnings Presentation, page 74
The downside is that Target’s growth could be limited since the U.S. is virtually a saturated market for retailers.
Comparable sales at Sam’s Club rose 2.7% in the fourth quarter of fiscal 2017, well above Walmart’s companywide growth rate of 1.9% in the U.S.
Growth prospects
Winner: Walmart
Walmart has better growth prospects because it is further along in its turnaround than Target.
The two biggest growth catalysts for Walmart and Target are e-commerce and small stores. Walmart has taken a lead in both areas.
Walmart turned to M&A to expedite its e-commerce growth. It acquired e-commerce platform Jet.com for $3.3 billion.
Source: 2016 Investor Meeting Presentation, page 4
Adding Jet.com allowed Walmart to instantly take a big leap forward in e-commerce. In the first 13 months after the acquisition, Walmart added 5 million new customers, thanks to Jet.com.
Walmart also owns a 10% interest in Chinese e-commerce giant JD.com.
Overall Walmart’s e-commerce sales jumped 29% in the fourth quarter. Worldwide e-commerce sales increased 22% for the year.
At the same time, Target’s e-commerce platform is performing well – digital channel sales doubled in the past three years.
But Target’s digital platform is still fairly small at $3.4 billion in 2016 sales. This represented less than 5% of Target’s total sales.
The next growth catalyst for big-box retailers in the U.S. is smaller stores. Stores with smaller square footage allow Walmart and Target to expand in big cities.
Densely populated urban areas typically cannot offer the square footage necessary to build a traditional store.
Walmart does this through its Neighborhood Markets banner, which is very successful. Neighborhood Markets comparable sales increased 5.3% in the fourth quarter.
Target has developed small stores under the CityTarget and TargetExpress banners. The problem is there are just 32 of these stores in operation.
Source: 4Q Earnings Presentation, page 75
By 2019, Target expects to more than triple its small-store count. But it will still operate just 100 stores by then.
For comparison, Walmart operated 699 Neighborhood Markets stores at the end of 2016.
Valuation
Winner: Target
Target recently announced a significant cut in its financial guidance for the upcoming year.
For 2017, Target expects a low single-digit decline in comparable sales, which measures performance at stores that have been open at least one year.
Adjusted earnings per share are expected to decline 16% to 24% in fiscal 2017.
The reason for the sharp reduction is that the company will be more competitive on price and invest more aggressively in new growth channels like e-commerce and small stores.
This was a huge reduction, and the stock has been hammered as a result. Target shares have fallen from $81 to $56 in the past year.
Such a huge drop is concerning, but it actually makes Target the more attractive buying opportunity. Target stock now trades for just 11 times 2016 adjusted earnings per share.
It may take time for Target to return to the same level of profitability, but its long-term earnings potential remains intact.
Meanwhile, Walmart is a less attractive stock to buy right now because it has already gotten credit for its turnaround efforts.
Walmart’s adjusted earnings per share declined 5.9% in the most recent fiscal year, but the declines are moderating, and the company has returned to sales growth.
After bottoming at $56 in November 2016, Walmart stock has rallied back to $70. Walmart stock now trades for a trailing price-earnings (P/E) ratio of 16.
The progress Walmart made over the past two years is largely priced into the stock valuation.
Dividend yield
Winner: Target
Both Walmart and Target have excellent dividend track records.
Walmart made its first dividend payment to shareholders in 1974. Back then, its quarterly dividend was just a nickel per share.
Today, Walmart’s quarterly dividend stands at 51 cents per share. Its dividend has risen tenfold since making its initial dividend payment.
Meanwhile, Target has made 198 consecutive quarterly dividend payments since its initial public offering in 1967.
Since Target’s share price has been hit hard since earnings, its dividend yield has elevated to 4.3%. This is an extremely high yield and represents a 10-year high for Target’s dividend yield.
Walmart’s dividend yield is much lower at 2.9%.
Target stock provides investors with approximately 48% more income based on the companies' current dividend yields.
Final thoughts
With a stronger financial performance and more compelling growth opportunities in the international markets, Walmart seems like the obvious winner in this matchup.
But Target’s recent share price crash presents a buying opportunity that is too good to ignore.
To be sure, Walmart is a high-quality dividend stock. For example, it is a far better choice than Amazon at current prices for conservative investors.
But Walmart isn’t the best retail stock to buy right now.
In the discount retail space, Target is the better dividend stock of the two, thanks to its significantly higher dividend yield and much lower valuation. Target outranks Walmart using The 8 Rules of Dividend Investing thanks in large part to its lower P/E ratio and higher yield.
Disclosure: I am long Walmart and Target.
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