Analysis of $TGT — Target Inc. Indicates That Now Is a Good Time to Buy! | Utradea

Valuation: Undervalued

An Investment Analysis Looking at Why You Should Consider Buying Target Stock:

  • According to the valuation techniques that I used throughout this analysis, I have reason to believe that Target is undervalued and could be a good stock to buy. I arrived at a final price target of $275/share, which implies an upside of 9.5%.
  • The effects of the pandemic were felt differently by different businesses over the course of the last year and a bit. While most companies suffered due to the pandemic, there were also some companies that benefitted massively from the pandemic.
  • Target is one company that did particularly well during the pandemic, however, with the pandemic seemingly starting to come to its conclusion, how will Target fare in the post-pandemic US economy?

Company Overview:

Target offers food, apparel, accessories, home décor, electronic, seasonal, beauty, and household products to their customers in the United States. Target sells their products in their 1,897 physical storefronts as well as their online (digital) store. Additionally, Target owns 51 brands that they carry in their stores nationwide.

Investment Information:

Target strives to be an employer of choice so that they can both attract and retain talented workers. Target aims to do this through talent development, engagement, diversity, inclusion, safety, benefits, and compensation plans.

Target offers a work environment that fosters growth and career-development opportunities. This includes providing their employees with the experience and skills necessary to “move up the ladder”. Furthermore, Target recognizes the importance of having a diverse and inclusive workforce, which is why they monitor their levels of diversity and report them in their Annual Workforce Diversity Report.

Additionally, Target has committed themselves to maintaining a safe working environment. They plan to maintain this safe environment through safety programs, which includes both occupation injury, and illness-prevention programs for their team members.

Lastly, Target offers their team members compensation and benefit packages to support them financially, mentally, and physically. Target has committed to a minimum hourly wage of $15/hour to their lowest-ranking members no matter their experience, gender, ethnicity, and offers many positions of advancement to their best workers. Furthermore, Target also has 401K matching programs (up to 5% of their annual wage), paid holiday, vacation, family leave etc., discounts, insurance, assistance programs, tuition reimbursement, incentive programs, equity awards, etc.

By offering all of these benefits, services, and opportunities to their team members, Target is likely to experience less employee turnover. This is important because low employee turnover rates can help Target to save money and time during the firing/hiring processes. Furthermore, these benefits, services, and opportunities are likely to increase employee morale and happiness, which can lead to their employees feeling more engaged/important which can make them more efficient, and even increase customer satisfaction. This is good for Target as a company as it will help them locate talent when they expand into new geographies, and it might even help increase revenues.

How Employee Satisfaction Affects Organizational Performance — HR Daily Advisor (blr.com)

Target has their own loyalty program that offers their customers 5% discount on most purchases when they use any of the eligible Target Red-Cards. Target has plans to leverage their loyalty program members to increase their visit frequency.

Target is able to offer their 5% cash back on in-store purchases, and 1% cash-back on all purchases that are not made in-store through their partnership with TD Bank. Targets RedCard penetration rate has consistently fell by an annual average of 4.95% (or 1.15 percentage points).

Target offers these cards to collect data from their customers for future marketing and planning events/activities to personalize them for their shoppers and increase engagement.

Furthermore, Target is able to make money through their RedCards by having a large credit spread. This is observed through Target’s high (24.40% variable) APR (Annualized Percentage Return). In 2020, Target made $560M off of their receivables from their debit and credit transactions (through their interest on late payments), however their sales reductions through discounts offered by these cards totalled $1.1B. This is up 27% YoY which outpaces their decrease in revenue from their cards which is 14% YoY.

In order to undergo my comparable analyses (seen in the “investment valuation” section of this report), I needed to find 4 companies that I could use to compare to Target in order to achieve a valuation.

These companies have to be publicly listed, operate in a similar manner, be of similar market cap, operate in similar geographies, and have valid financial ratios and multiples.

By using the above criteria, I arrived with the following 4 companies that I used in my comparable:

$COST — Costco Wholesale Corp: Costco is a consumer defensive, discount store chain that operates worldwide, however their main operations take place in the USA. Like Target, Costco also carries many brands that they own themselves (among other brands) and sells a variety of products including food, apparel, electronics, appliances, health and beauty etc. Costco has 552 stores in the USA and is a direct competitor to Target.

$WMT — Wal-Mart Inc:Wal-Mart operates their supercenters, supermarkets, hypermarkets, and discount stores in the US and internationally. Like Target, Wal-Mart is heavily involved in the USA, and offers food, grocery, beauty, health, appliances, home improvement etc. products to their customers. Like Target, Wal-Mart also has an online marketplace.

$DG — Dollar General Corp:Like Target, Dollar general is a discount store that only operates, and serves their customers in the USA. Furthermore, they both sell food, perishables, beauty products, personal care products etc. Dollar General has over 17,000 stores in the USA (which is significantly more that that of Target.

$DLTR — Dollar Tree Inc:Like Target,Dollar Tree operates their discount variety stores across the USA. However, Dollar Tree offers most of their products for $1, which is one of their selling features. Dollar tree also has similar product offerings to that of Target; however, their selection is not as diverse, and their products are typically not of higher quality.

Like many other companies, Target was adversely affected by the COVID-19 pandemic. However, in light of this pandemic Target invested $1B into programs to help their team members well-being, health, and safety, which included bonuses paid-leave, wellness resources etc. I believe that by Target taking this initiative amidst uncertain financial results in their future shows that they care for their workers, which reflects well on their brand, image, and potentially productivity and employee retention.

Furthermore, Target acted quickly to ensure that they met the safety, social distancing, and cleanliness measures in place due to the pandemic.

Target experience sales decreases during the start of the pandemic, but this reduction in sales was not long lived and Target was able to bounce back relatively quickly. Furthermore, Target was tasked with navigating and fixing their supply chains, as the pandemic resulted in many supply chain shortages. Target was able to manage their supply chains during the pandemic and did not lose much revenue as a result of supply chain issues.

Overall, Target was able to navigate their way through the pandemic without too much material effects on their business. This ability to navigate through the uncertainty helped Target to achieve greater sales figures than their pre-pandemic financial results.

Financial Information:

  • Financial Performance (Good): In 2020, Target’s sales increased by 20%, their total revenues increased by 20%, their operating income increased by 40%, their EBITDA increased by 24%, their EBIT increased by 39.8%, and they increased their net operating profit by 40%. Furthermore, in 2020 Target was able to open 30 new stores, while only needing to close 1 store, this means they netted 29 new stores, which increased their total stores by 1.5%.
  • Financial Performance (Bad): There is always some bad that comes along with the good, and in 2920 Target had some areas on their financials which were not favourable. Targets cost of sale increased by 21%, which is more than their increase in revenue. This contributes to a lower overall gross margin for Target. Furthermore, Target’s interest expense increase by 105% which is a sizable increase. This was really the only bad that came from Target’s financial performance, which is a fantastic sign for investors.
  • Share Repurchasing:In 2020, Target repurchased 5,700,000 of their common shares. This repurchase increased the value of the existing shares on the market by approximately 1.13%. This is great to see as an investor, and Target has a track record of repurchasing shares which is even better.
  • Stock Options and Awards: In 2020, Target issued 2,400,000 shares through option exercising and employee stock awards. Target’s stock awards come in the form of RSU’s (Restricted Stock Units) and PRU’s (Performance Restricted Units). In 2020, Target vested 1,427,000 common shares through their RSU’s, these vested shares are no longer restricted and were added to their total shares outstanding. Furthermore, Target vested 827,000 PRU’s which became un-restricted and were added to the shares outstanding. The remaining 146,000 shares were distributed to the market through the exercising of employee options.
  • Total Dilution: In 2020, Targets total shares outstanding decreased signifying that each share represents a larger portion of the company than they di 1 year ago. I call this “share inflation”, and Targets shares were inflated by 0.65%. This is fantastic to see as an investor, however Target has inflated their shares by a larger amount in the past (ie. 2.6% in 2019, and 4.4% In 2018). However, this decrease can be attributed to the temporary suspension of their share repurchasing program due to COVID-19.

Valuation Information:

I was able to calculate my own WACC through taking the average result from both my High and Low WACC estimates. By doing this I arrived at an average WACC of 6.91%, which I used in my model.

I was able to find Targets gross profit CAGR to be close to 7% over the past 4 years. However, as a result of Targets increased business due to COVID-19, I decided to take a more conservative estimate of 6%.

Operating Expense Increase Rate:

Over the past 4 years, Targets operating expenses have increase by an average of 6.7% annually. I used this historic increase to predict future results.

Interest Expense Increase Rate:

Over the past 4 years, Target’s interest expense has grown at an average rate of 9.8% per year, which I used to forecast future results.

Depreciation and Amortization Increase Rate:

Over the past 4 years, Target’s depreciation and amortization has grown steadily at an average annual rate of 0.67%.

I was able to find Target’s effective tax rate for the year 2020 to be 21.2% through Targets SEC 10-K filing.

Capital Expenditures Decrease Rate:

Over the past 4 years Target has reduced their capital expenditures by an average of 1.2% per year.

Risk Free Rate:

I found Target’s risk free rate to be 2.25% from a website called “ Finbox “, which estimates certain rates (like “risk-free) that are used in financial modelling.

Investment Valuation:

I used the information found above in the “valuation information” section of this report in order to arrive at a fair value of $337.19/share for Target. This price implies that Target is undervalued, and has an implied upside of 34.28%.

However, in my sensitivity analysis of my DCF model, the lowest and highest valuations that are within +/- 1% of the estimated WACC and Risk-Free Rate are $247–490. These valuations imply that the most conservative estimate for Target is $247 and implies a downside risk of 2%. While the most optimistic valuation implies a potential upside of 95%. Therefore, it is pretty safe to say that Target is undervalued and has some room to grow into.

In order to get a rounded valuation via a comparable analysis, I decided to compare 3 of Targets financial ratio and multiples to that of their competitors (listed above in the “competition” section of this report). These comparable multiples and ratios are as follows:

By comparing Target’s EV/EBITDA multiple to that of their competitors, I found Target’s fair value to be $257/share, which implies an upside of 2%. This comparable implies that Target is in fact undervalued and supports the original argument made by the DCF model.

By comparing Target’s EV/Revenue multiple to their competitors, I arrived at a fair value of $215/share, which implies a downside of 15%. This is the only valuation that implies that Target is undervalued, so I decided to do one more comparable to get a final consensus.

By comparing Targets P/E ratio to that of their competitors, I arrived at a fair value of $314/share, which implies an upside of 25%. This confirms that Target is undervalued and is similar to the result as achieved in the DCF model.

Average Comparable:

In order to get one all-encompassing valuation from my comparable analyses, I decided to take the average of the 3 results which I arrived at. By doing this I arrived at a final fair value of $262/share, which implies an upside of 4%.

Dividend Discount Model:

The final valuation model that I used in order to value Target is a Dividend Discount Model. This model factors in the average growth rate of Targets dividend, their WACC, and this year’s total amount paid in dividends. By doing this I arrived at a fair value of $226, which implies a downside risk of an investment into Target of 10%. This is the only valuation metric that argues that Target is overvalued.

Plan:

When formulating my investment plan, I decided to take the average result achieved through the 3 different valuation models/techniques used in my valuation. By doing this I arrived at one fair value of Target of $274.99/share, which implies an upside to this investment of 9.5%.

Risks:

  • Post-Covid Sales Slowing: In their SEC 10-K filing, Target stated that they exhibited better sales figures as a result of the pandemic. This helped Target to outperform in 2020, however, what will happen once Covid-19 is no longer a factor? If Targets sales stagnate or even decrease after the pandemic, it would hurt their stock price.
  • Financial Performance: Although Target’s financial performance in 2020 was good, there is still room for error in the future. Currently, it appears as though Target is moving in the right track and has the potential to continue to post good earnings. However, investors may start to expect this, and if Target starts to fall short on their earnings, then these investors may be quick to exit.

Catalysts:

  • Share Repurchasing: Overall, in 2020 Target purchased more shares than they offered to the markets. This in itself is a very good sign and will help increase value for shareholders over the long run. However, the best part of all of this has to be that Target was able to achieve this feat after their repurchasing program was temporarily suspended. Maybe we will see Target repurchase more shares this year to make up for the suspension, who knows? However, if they can keep up this share “inflation” than Target will continue to remain an attractive buy.
  • Financial Performance: Overall, in 2020 Target had a fantastic financial performance. If Target can continue to overcome adversities and continue to have good financial performances consistently, then more investors will be interested and buy shares which will help the share price.
  • Post-Covid Performance: We know that Target’s great financial performance this year can be attributed to the effects of COVID. We know this because Target stated it in their annual report, however if Target is able to maintain a similar financial performance after COVID-19 has concluded, they will prove to investors that they did not just “get lucky” with COVID-19, and that they can continue to perform well.

Originally published at https://utradea.com.

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Utradea

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The social platform for investment ideas and insights. Check out utradea.com for the latest investment content.

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