Why Target Is a Buy Right Now
A forthcoming move into Canada is just one reason the stock looks poised to gain in the coming years.
Target (TGT) should be bought at $50 -- and the reasons why are plentiful.
The stock price has declined following a poor holiday quarter comparable-store gain. The company is about to enter Canada, and may see some of its US competitors, Kmart and Sears (SHLD), close within the next two to three years. And, finally, the possibility of slow economic recovery in the U.S. should help Target continue to grow and work its "marketing magic."
Canada just cries out for a Target entry in my opinion. Statistically, sales per square foot are USD $507 in Canada versus $309 in the US. Square feet-per-capita is 14 there versus 23 in the US. The competitors are Wal-Mart (WMT) and Costco (COST), which is nothing new, Sears, which is hurting, Canadian Tire (CTC.TO), Loblaw's (L.TO), Home Hardware, and The Bay, a department store chain. That does not look daunting at all to me. Starting in the '90s, I was surprised at the comparable-store sales that TJX's Winners (TJX), a TJMaxx/Marshall's type store, would always put up. The fact that Target is entering Canada by buying out leases of Zellers, a Canadian chain with customer demographics similar to Target's, means that they are not significantly adding to square footage in the market, as well.
Another reason the move in to Canada will help Target is that pricing in Canada is high. On a trip to Mt. Tremblant, Quebec, this summer I stopped at two outlet malls for my wife. We bought nothing. We were both aghast at the prices. The numerical prices were the same she would have expected to pay in the US, but they were in Canadian dollars, which were maybe 15%+ higher than the US dollar at that time. Doing a store check of Abercrombie & Fitch (ANF) around Labor Day I saw a price tag made for both the US and Canada that showed suggested retail to be 30% higher in Canada.
Target management is looking for an $.80 contribution to EPS in 2017. Sell side estimates for a 2012 EPS of $4.25 are presently being hurt by $.50 for expenses associate with the Canadian entry.
Consider the Domestic Landscape
Within the US, comparable-store sales had been showing some strength before the holiday quarter. But December same-store sales sales were up only 1.6% versus a 4% consensus and a 3% comparable-store sales increase in the third quarter. My perspective is that Kohl's (KSS) and J.C. Penney (JCP) also had poor sales at the holidays; everybody under the Macy's (M) average price point saw sales drops, as the less affluent had plenty to worry about this year. Part of the problem in Target's case, cited by management, was electronics, movies and books, all of which are open to heightened Internet competition and are higher proportions of total sales around Christmas. Target's PFresh program, which promotes fresh foods and increases consumables floor space, and the store's new RedCard, which provides a 5% discount on charged purchases, were important same-store sales movers prior to Christmas and should contribute to higher same-store sales increases in 2012.
The latest announcements -- that Target will introduce various rotating six-week mini-stores within the larger stores, and that the company is running a 25-store test of permanent small Apple (AAPL) stores within Target -- are icing on the cake and evidence that there is still "magic" in their marketing. The $5 billion share buyback over three years announcement is nice, too. But I was planning on writing this before these announcements came.
At $50, Target stock, using a 4% risk-free rate (3% 30-yr. Treasuries +1% for Fed's holding them at too low a level) and a 6% risk discount -- used for the strongest retailers such as Lowe's (Low) and Home Depot (HD) -- discounts a near 1% perpetual earnings growth rate off of 2012's $4.75 adjusted EPS estimate ($4.25 estimate + $.50 of Canadian expenses that are not going to start to reverse until early 2013 when the first Canadian stores open). But even without Canada, Target earnings would tend to grow with US GDP growth that should be closer to 2% in a worst-case scenario, with no recovery from the last recession. EBIT margin should come in around 7.6% for FY 2012, .2% under last year's (8.3% was achieved before the last recession and the recession year of 2008 hit 6.8%). There should be some moderate downward trend in a 30.1% GM for more expensive Chinese sourcing and a slight downward trend for a higher more consumables sales mix, countered by some moderate SG&A leverage. Net, I see no particular pressure. On the upside will be the continued closings of Sears and Kmart stores as far as my eye can see, and some moderate market share gains in the US, even without the Sears contribution.
Distilling these assumptions, I think that a 3% five-year growth rate and a terminal 2% growth rate is justified without any real recovery from recession in the US. That justifies a $58 price, 17% appreciation.
With a successful Canadian market entry, management has stated that Target could earn $8 per share in 2017, which would be a 16% compound annual growth rate from the 2012 EPS estimate of $4.25. Assuming that that growth rate quickly subsides (two-year transition) to the former trend line, the implied price stock value is $83, a 68% appreciation. I will not use management's estimates, as managements are generally optimistic, but nobody has to. Just the midpoint of the justified prices is $70, a $40% appreciation versus my 20% buy-rating requirement, though the stock will probably work over an extended time period versus others.
Assessing the Risks
Starting with holiday sales, the first risk is that Amazon (AMZN) will continue to grow and operate without collection of sales taxes. I cannot see that happening longer-term. There is the risk that Target will lose even more business to online sales, including clothing sales, especially as companies develop advanced technology to display clothes according to a customer's exact size. But given that most Targets are not the size of the successful superstores, and given the success of the PFresh initiative, I could see Target using the incremental excess space for more consumable offerings. And given the IT problems Target saw after the Missoni promotion, I would hope and expect that Target would strengthen its Internet capabilities quickly.
There is the risk that the US economy will go into a recession again via the European debt crises. But I think that the extreme undervaluation more than counters that. A Chinese recession, or 3% or less growth would be the biggest risk (so I am told by economists). Besides hitting the US, it would hit Canada's natural resource-based economy hard. Somewhat mitigating that risk is that Target's 2013 openings will be heavily in the more service-based economy of Ontario.
Follow the markets all day every day with a FREE 14 day trial to Buzz & Banter. Over 30 professional traders share their ideas in real-time. Learn more.
Daily Recap Newsletter