Target’s (NYSE:TGT) stock price is still down by about 15% from its 52-week high, despite the fact that it already bounced back by more than 20% from its February 2022 lows. In March 2022, the firm presented impressive financial results, including record revenue and record net earnings in FY2021. Although the financial performance of the company looks strong, when considering investing in the company, we need to understand, what is the right price to pay for the stock and what potential risks do we face?
Growing revenue and improving margins
Target has reported a record $104.611 million total revenue in FY2021. This represents a 13.3% increase compared to the year before. Not only the total revenue but also the operating income has increased by an impressive 36.8% compared to a year ago, reaching $8.964 million. Net earnings in 2021 reached $6.946 million, indicating a 59% Y/Y increase.
These growth figures can be attributed, on one hand, to Target’s digital growth strategy, which outpaced its peers in the industry. On the other hand, to the increased traffic in the physical stores. The firm has also managed to keep and solidify the shares it gained in the market from its competitors in 2020.
We believe it is important that in such a competitive market, with competitors including Walmart (WMT), Dollar General (DG), Kroger (KR) and even Amazon (AMZN) in the digital space, the firm managed to keep its market share. This serves as proof that the business model is solid and validates the growth initiatives started earlier.
Although digital growth is important, still 95% of sales are generated in physical stores. Keep this in mind, because a potential Covid-19 outbreak could have significant impacts on physical store sales.
The total sales can be distributed to five main business segments: beauty & household essentials, food & beverage, home furnishing & décor, hardlines, apparel & accessory. The following figure shows how each of these segments contributed to total sales in 2021. The largest segment by far is the “beauty and household essentials” accounting for 26% of the 2021 total sales.
In our opinion, it is of advantage that the other 4 segments of Target are almost contributing equally to the total sales. This allows the firm to not have to rely on individual segments, making it easier to navigate through challenging times in case supply chain issues impact individual segments.
To sustain the growth and to continue the successful initiatives, Target aims to remodel an additional 200 stores per annum in the years to come, in addition to the 2000 stores already remodeled. The company also aims to increase its offerings of highly popular products and brands, including Ulta Beauty (ULTA), Disney (DIS), Apple (AAPL) and Levi’s (LEVI). The expansion of the chain is also foreseen by adding approximately 30 new stores yearly in order to increase the footprint of Target and reach a more diverse base of customers.
In our view, adding popular brands will help Target address and provide for the needs of different age groups, creating potential for further sales growth. Although “Beauty and Household essentials” is already the leading segment in sales, the addition of Ulta Beauty products to Target’s product portfolio will potentially further strengthen the segment’s performance.
The firm has also managed to consistently widen its operating margin rate on an annual basis, reaching 8.4% in 2021.
We believe improving margins in an inflationary environment proves Target’s pricing power and its ability to pass over increasing costs to its customers.
Target is also aiming to make an impact in terms of ESG initiatives, investing heavily into its team and providing workers with benefits, such as creating a new starting wage range, providing vulnerable leave, and vaccination pay. This could be a plus for investors who want an ESG focus.
Looking at Target’s strong 2021 performance, it can be concluded that the firm is financially well-positioned and has been able to successfully implement its growth initiatives so far, with no intention to stop. In our opinion, Target has further room to run, reaching a wider audience and even potentially gaining further market share.
To sum up, we believe Target is a great business. On one hand, it provides growth to investors by successfully executing its initiatives. On the other hand, by having a wide range of products, with significant pricing power and increasing operating margins, the firm could provide great inflation prote
ction for shareholders.
We have seen that Target’s financial performance is strong and it is valuing its shareholders both with capital gains, dividends and share buybacks. But how much should we pay for TGT’s shares?
The firm’s current price-to-earnings ratio of ~17 is about 50% more than the sector median of 11.35. Not only the P/E ratio but also the price-to-sales and price-to-free cash flow ratios are higher than the sector median. Based on these three ratios the firm seems to be overvalued.
However, in our opinion, when comparing the firm to its sector, the comparison may be misleading, because we need to account for the company’s growth potential. As we have seen, TGT is on a growth trajectory currently, therefore this premium P/E ratio may be justified.
Let’s look at how the current P/E ratio compares with its own historic average.
According to its own history, TGT is currently trading at a premium as well. The 10-year average P/E ratio of the firm is 14.7.
In our view, Target is trading both above its own historic average and above the sector median in terms of P/E ratio. We believe the firm’s moderate growth does not justify such a premium. For now, it is better to wait until the stock price drops further before jumping in and starting a new position. If you already own TGT’s stock, we would hold it at this moment, as the financial performance of the company is strong with moderate growth potential.
What could be the fair value of TGT stock now? Analysts estimate the EPS in the upcoming four quarters to be in the range of $13.01 to $16.42. Based on the sector median P/E ratio, it would mean a fair value for Target’s stock between $148 and $186 per share.
As the stock is currently trading around $225, an additional 20%-25% drop in stock price could result in a suitable entry point.
Because of the firm’s solid performance, TGT shareholders have been nicely rewarded in 2020 and 2021. But capital gains are not the only way the firm is rewarding its shareholders.
Target has a long history of paying dividends. In Q4 2021, the firm paid its 217th consecutive dividend since the company became publicly traded in October 1967.
According to a payout ratio of 23.32% the firm can safely cover and sustain its dividends.
In our opinion, Target’s 1.56% dividend yield can be attractive to investors looking for sustainable and increasing dividends. In the last 53 years, TGT has proven its strong commitment to return value to shareholders in the form of reliable dividend payments.
Further, Target also creates value for its shareholders by consistently purchasing back its shares. In 2021, the board announced a $15 billion share repurchase program, with no expiration indicated. The firm has already bought back 11.3 million shares for a total of $2.7 billion.
In our view, based on TGT’s buyback history, which is expected to continue in the years ahead, the company’s stock may be an appealing investment opportunity for investors looking to invest in a more defensive industry.
To have a full picture of Target’s business, the key risks need to be highlighted. This list does not aim to cover the full range of risks Target’s business is subjected to. An exhaustive list can be found in TGT’s annual report.
- Inflation and rising input costs
Although Target has managed to improve its operating margins in 2021, we have yet to see financial results from 2022. We believe that the company’s short-term success will be crucial and whether they can keep passing over the increased costs to the customers.
2. Product differentiation problems
As the sector is extremely competitive, the companies are trying to set themselves apart by differentiating their products. This product differentiation plays a significant role in who can gain and who loses market share. In our opinion, Target’s initiative of expanding its product offerings from popular brands, including Ulta Beauty, Disney, Apple and Levi’s, puts the firm in a favorable position.
3. Supply chain and third-party risks
Ongoing political tensions in Eastern Europe and Covid-19 outbreaks in China may impact Target’s business directly or indirectly.
Target had a strong financial performance in 2021.
The growth is expected to continue based on TGT’s strategy to keep implementing successful initiatives, including store remodeling.
Target also pays close attention to the welfare of its employees, by not only providing training and increased entry wages but by expanding healthcare benefits.
According to the current stock price, Target is trading at a premium, therefore we would recommend waiting for further price drop before starting a new position.