Wednesday, November 28, 2012

Target Stock Analysis

I've been wanting to pick up some shares of Target (TGT) for a while but the price has always been just out of reach for me.  It's getting close to where I'd feel comfortable initiating a position so I figured I'd post my stock analysis on the company.  During trading on Tuesday, November 27th shares were trading for $62.95.

Company Background:

Target Corporation operates general merchandise stores in the United States. The company offers household essentials, including pharmacy, beauty, personal care, baby care, cleaning, and paper products; hardlines comprising music, movies, books, computer software, sporting goods, and toys, as well as electronics that comprise video game hardware and software; apparel and accessories consisting of apparel for women, men, boys, girls, toddlers, infants, and newborns; and intimate apparel, jewelry, accessories, and shoes. It also provides food and pet supplies, including dry grocery, dairy, frozen food, beverages, candy, snacks, deli, bakery, meat, produce, and pet supplies; and home furnishings and décor, such as furniture, lighting, kitchenware, small appliances, home décor, bed and bath, home improvement, and automotive products, as well as seasonal merchandise, which include patio furniture and holiday décor. The company sells its merchandise products under private-label and exclusive licensed brands. In addition, it provides in-store amenities. As of November 15, 2012, the company operated 1,782 stores in the United States. Further, it offers general merchandise through its Website, Target.com. The company distributes its merchandise through a network of distribution centers, as well as third parties and direct shipping from vendors. Additionally, it offers credit to guests through its branded proprietary credit cards, the Target Visa Credit Card and the Target Credit Card, as well as through its branded proprietary Target Debit Card.

DCF Valuation:

Analysts expect Target to grow earnings 11.77% per year for the next five years and I've assumed they can continue to grow at 3.50% per year thereafter, slightly above the long term inflation rate. Running these numbers through a DCF analysis with a 10% discount rate yields a fair value price of $93.92. This means that at $67.95 the shares are undervalued by 33.0%.

Graham Number:

Over the last 12 months, Target's EPS were $4.51 and it's current book value per share is $24.98. The Graham Number is calculated to be $50.35, which means it is currently overvalued by 25.0%.

Average High Dividend Yield:

Target's average high dividend yield for the past 5 years is 1.98% and for the past 10 years is 1.48%. This gives target prices of $72.78 and $97.04 respectively based on the current annual dividend of $1.10. These are undervalued by 13.5% and 35.1%, respectively. I think the average high yield is going to be creeping higher over the next few years so I'll use the higher 5 year average price target in the fair value calculations.


 Average Low PE Ratio:

Target's average low PE ratio for the past 5 years is 11.00 and for the past 10 years is 12.63. This corresponds to a price per share of $47.09 and $54.08 respectively based off the analyst estimate of $4.43 per share for the fiscal year ending in January 2013.  The 5 year and 10 year low PE price targets are overvalued by 33.7% and 16.4%, respectively.  Both of the average low PE ratios are close to each other so I'll use the lower 5 year average price target for the fair value calculations.

Average Low P/S Ratio:

Target's average low PS ratio for the past 5 years is 0.43 and for the past 10 years is 0.54. This corresponds to a price per share of $47.56 and $59.55 respectively based off the analyst estimate for revenue growth from FY 2012 to FY 2013.  Their current PS ratio is 0.57.  The 5 year and 10 year low PS price targets are overvalued by 32.4% and 5.7%.

Dividend Discount Model:

For the DDM I assumed that Target will be able to grow dividends for the next 5 years at the minimum of 15% or the lowest of the 1, 3, 5 or 10 year growth rates. In this case that would be 15.00% since the acutal growth rates have been higher.  After that I assumed they can continue to raise dividends for the next 5 years at 75% of 15.00%, or 11.25%, and by 3.50% in perpetuity.  The dividend growth rates are based off fiscal year payouts and don't necessarily correspond to quarter over quarter increases.  To calculate the value I used a discount rate of 10%. Based on this, Target is worth $45.20 meaning it's overvalued by 39.3%.

PE Ratios:

Target's trailing PE is 13.96 and it's forward PE is 12.82.  The PE3 based on the average earnings for the last 3 years is 16.31. I like to see the PE3 be less than 15 which Target is currently higher than this threshold.   Compared to it's industry, TGT seems to be undervalued versus COST (24.92) and WMT (14.38).  Against the industry as a whole, Target is undervalued with the industry carrying a PE ratio of 23.68.  All industry comparisons are on a TTM EPS basis.  Target's PEG for the next 5 years is currently at 1.24 while Costco is at 1.71 and Walmart is 1.54.  A low PEG ratio is better because it means that you're paying less for the growth of the company.

Fundamentals:

Target's gross margin for FY 2011 and FY 2012 were both 30.9% and 31.2% respectively. They have averaged a 32.3% gross profit margin since 2001 with a low of 30.9% in FY 2012. Their net income margin for the same years were both 4.3%.  Since 2001 their net income margin has averaged 4.23% with a low of 3.40% in FY 2001.  I typically like to see gross margins greater than 60% and at least higher than 40% with net income margins being 10% and at least 7%.  Obviously Target fails both of these criteria, however each industry allows for gross margins in certain ranges.  Target's discount retail industry is a lower margin one so it pays to compare their margins to their competitors.  For FY 2012 Target captured 119.8% of the gross margin for the industry and 113.5% of the net income margin.  This is very promising because it means that their operations are possibly more efficient and that they have some pricing power.  It also means that for every $1 in revenue they are able to turn more into profit for the company that be either be reinvested back in the company or returned to shareholders.  Their cash-to-debt ratio for the same years were both 0.04.  I prefer for company's I'm investing in to have very little debt on their books and to have a much better better cash-to-debt ratio than virtually 0.  This is the only real blemish from a fundamentals perspective.

Share Buyback:

Target's shares outstanding increased from FY 2001 through FY 2004 but has been dropping significantly since then.  They have decreased on average 2.65% of the shares outstanding since FY 2001 ended which is  pretty impressive considering they had 3 years of increases with a total of 25.56% of their shares outstanding being retired since the end of FY 2001.  Share buybacks are another way that management can essentially return cash to shareholders and it's great that they are siding with their investors.


A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.

Dividend Analysis:

Target is a dividend champion with 45 consecutive years of dividend increases.  Their current annual dividend sits at $1.44 for a current yield of 2.29%. TGT's annual increase for the last 1, 3, 5 and 10 years have been 30.95%, 22.39%, 20.11% and 17.46%. These numbers are different from the actual quarterly increases since these are based off the dividends paid out during each fiscal year.  Despite the really nice DGR, their payout ratio has only increased from 15.2% in FY 2001 to 25.7% in FY 2012.  The highest payout based off earnings was the recent FY 2012 rate of 25.7%.  Considering they've been growing the dividend at over a 17% annual increase over the last 10 years, it's very nice to see that the payout ratio hasn't increased at the same rate.


Their FCF per share leaves a little to be desired but if they can continue the FCF that they had during FY 2010 and 2011 then it won't be anything to worry about.  I would like to see the FCF payout ratio come down because it will show that management is able to have more cushion for down years.


Return on Equity and Return on Capital Invested:

Target's ROE has averaged 17.38% since 2001 with a low of 14.50% and a high of 19.40%.  Their ROCI has averaged 9.20% since 2001 with a low of 7.10% and a high of 11.50%.  For both ROE and ROCI I don't necessarily look for any absolute values rather I like to see stable to increasing levels over the long term which Target has accomplished.


Revenue and Net Income:

Since the basis of dividend growth is revenue and net income growth, we'll now look at how Target has done on that front.  Their revenue growth since 2001 has been a respectable 5.97% per year but their net income has been growing at an 7.94% rate since 2001.  Since their net income has been growing faster than revenue their net income margin has increased from 3.43% to 4.19%.  This means that management has been able to get operations more efficient and they are able to keep more pennies from every dollar of sales to reinvest in the company or return to shareholders.  Revenue has grown in every year except for between FY 2004 to FY 2005.


Tangible Book Value:

Target's tangible book value per share has grown every year since 2001 with an average annual increase of 11.34%.  It's very nice to see that they've been able to increase the TBVps of the company every year.  A company's tangible book value per share is what common shareholders can expect to receive if the firm went bankrupt and all of its assets are liquidated at their book values.  It takes out the intangible assets from the equity of the company.


Forecast:



The chart shows the historical prices since 2001 and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio for the previous 5 years and 10 years whichever is least.  Since I think the 5 year average low PE of 11 is going to be more typical for TGT I'll use that number.  I like to the look to buy at the 75% Low PE price or lower to provide for additional margin of safety. In this case the target low PE is 11.00 and the 0.75 * PE is 8.25 . This corresponds to a entry price of $36.56 based off the expected earnings for FY 2013 of $4.43.   Currently Target is trading at a $26.39 premium to the 75% low PE target price.  I don't think you'll see Target trading for a sub 10 PE ratio so but purchasing on the low end of their PE valuation range around 11/12 could prove to be the right move.

Conclusion:

The average of all the valuation models gives a fair value $60.65 which means that Target is currently trading at a 3.8% premium to the average fair value. I've also calculated the fair value with the highest and lowest valuation methods thrown out.   In this case, the DCF and DDM valuations are thrown out and the new average is $56.19.  Target is trading at a 12.0% premium to this price as well.

Overall I would say that Target is at a price that I would be comfortable initiating a position but not quite at a truly undervalued price just yet.  My average fair value calculation is more of a low value price target since I'm taking the low PE, dividend and PS ratios to calculate the value.  Picking up shares for less than my "average fair value" calculation price targets is usually a sign that you're getting a really good value on the shares as long as nothing has fundamentally changed with the company to give prices that low.  As as DG investor the starting yield is lacking on Target but could be made up very quickly if their DG can remain at the elevated rate for several more years.  Target is just now beginning to expand internationally by starting to open up stores in Canada.  If the penetration rate in Canada gets to a similar level as in the United States then this will be a huger driver of growth and eventually dividend growth going forward.

I'm very close to starting a position with Target because I've been watching it for a long time and just never got the chance to buy any.  It's price is now getting to reasonable levels so I just might be picking some up soon.  I would like to get a 2.50% yield on the shares but that is at $57.60 which is a further pullback of 8.50%.

What do you think about Target as a DG investment at today's prices?

3 comments:

  1. Target is in a very tough market in the retail sector. When you must compete against the likes of walmart you have your work cut out for you. Walmart is the elephant in the room theirs just no getting around it.

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    1. I agree that Walmart is a big competitor but I think that Target will be fine because their target consumer is more in the middle to upper middle whereas Walmarts are targeted more towards the lower to middle. That might not be how Walmarts management sees it but it is what it is. With TGT's expansion into Canada, they just recently opened their first store and will be opening several more later this year, it'll provide a growth aspect in addition to the growth of the overall US consumer market. I probably wouldn't be initiating a position right now but I liked where I picked some up closer to $60. Another dip there and I'd feel comfortable adding more but depending on the portfolio makeup at the time there might not be room.

      Thanks for stopping by!

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