Target Corp. (TGT, Financial) touched a near-term high of $78.6 on Nov. 25, 2016. Since then, the stock has been on a sustained decline and is currently lower by 30% at $55.2.
In general, the holiday season is positive for retail stocks; the first reason for Target's decline was a relatively challenging season in terms of sales. Target was trending higher prior to the holiday season and as numbers began flowing, the company’s stock declined. This decline was accelerated by the company’s fourth-quarter 2016 numbers that were announced on Feb. 28.
The results reflected a weak holiday season, and Target provided a relatively muted outlook for fiscal 2017. These factors combined to translate into a sharp decline for the stock in the last few months.
However, a 30% correction in a short time frame is sharp, and there are developments that can reverse this downside. I am not suggesting an immediate stock surge, but value investors can consider exposure at current levels.
Valuations attractive
Since the stock has seen sharp correction, the first point on which I want to focus is valuations. I will then discuss the business developments that can trigger stock upside in the medium to long term.
The company expects a low-single digit decline in comparable sales. This factor is discounted in the recent downside.
Considering the company’s outlook for GAAP EPS of $3.8 to $4.2 per share and considering midrange of the guidance at $4.0 per share, Target is currently trading at a forward price-earnings (P/E) of 13.8. These are appealing valuations considering broad market valuations and factors I will discuss later in this article.
It is also worth mentioning here that Target currently has a dividend payout of $2.4 per share, which translates into a healthy dividend yield of 4.2%. The dividend payout is sustainable through fiscal 2017, and this makes valuations look even more appealing.
Being in a bearish trend, the stock can see another 5% correction from these levels, but I see current levels as worth accumulating, and any further correction provides more opportunities.
Digital sales remain robust
For Target, digital sales might not be the factor that translates into immediate turnaround for the company, but robust sales are increasingly contributing to the business and give the management a clear direction in terms of investments going forward.
According to the company’s call transcript:
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. In addition, we will invest in lower gross margins to ensure we are clearly and competitively priced every day.
Clearly, the focus is in investing more in digital stores and with the company investing $1.0 in operating margins for fiscal 2017, the aim is to gather market share through competitive pricing with some sacrifice on the margin front.
The company’s assessment is realistic and provides a near-term vision that might be higher volumes of sales but some contraction in margin. This is likely to be the way forward for the industry where competition is high and Target is not an exception.
Importantly, as digital sales continue to pick up, the company’s long-term outlook still looks positive, and digital sales can largely offset decline in physical store sales in the coming years.
Small stores delivering value
One of the strategies for Target is to have small-format stores in areas where big stores are not possible. In fiscal 2016, the company opened 32 small-format stores in prime urban neighborhoods and on college campuses among others. These stores have twice the sales productivity as compared to the company’s conventional store and even with higher operating cost, the returns generated are healthy.
In the future, Target plans to open 40 stores on an annual basis in this format, and this is another subsegment that will provide support to sagging comparable sales growth.
In addition to small stores that are delivering value, Target also plans to reimage stores that are in the larger format with an aim to attract consumers and drive sales on the upside. While these initiatives will take time to deliver results, the company has realistic views and is progressing in the right direction.
Conclusion
Target reported weak results for fourth-quarter 2016, and the company’s outlook for fiscal 2017 is not bright either. However, the stock has already witnessed deep correction, and the negatives are largely discounted in the stock.
Considering the company’s focus on digital stores, small-format stores and remodeling of existing stores, the long-term outlook remains bright. The company is willing to cut on margin to remain competitive, and that might be the way forward for retail stores.
Disclosure: No positions in the stock.
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