Our price target analysis has maintained Target (TGT) at a Buy with a price target of $110 for 2013. For this projection, our calculations suggest buying below $87 and selling above $122. With the current stock price at $63, TGT is a strong buy. Starting in April/May of this year, TGT has extensive plans to expand and open over 100 stores in Canada. The company will also be offering its credit and debit card services in these new locations. This process involves spending $1.5B this year and $500M next year in hopes of seeing more than that in profits gained from this expansion. While we do not see TGT having a strong economic moat, we believe certain aspects of its exclusive fashion lines give them a unique quality from other discount stores. Although its expansion plans in Canada will provide a large increase in revenue, any problems in this process could cost the company and change the future outlook for our price target. Regardless of this risk, we identify TGT as a healthy company that will continue to turn profits, increasing its value in the coming years.
TGT is presently operating with a P/E of 14.1, which is lower than the industry average of 16.3, and a future P/E at 13.2 (we look for below 15 for value). A decrease in P/E from trailing to future means that the company's earnings are predicted to grow. The question, though, is TGT's value representative of opportunity or does it show weakness in the company.
During Q3 2012, TGT increased sales YoY by 3.4% to $16.6B. TGT has also seen a 4.6% increase in net earnings from $1.9M in Q1-Q3 2011 to $2.0M in Q1-Q3 2012. These numbers are slightly weaker than TGT's competitor Wal-Mart (WMT), which reported a 3.4% increase in sales YoY for Q3 as well as a 5.4% increase in net earnings. Another competitor, Costco Wholesale Corporation (COST), reported an 8.2% increase in sales YoY during Q3 of 2012. COST also had an impressive 10.6% increase in net earnings during the first three quarters of the 2012 fiscal year from 59.46 billion in 2011 to 66.54 billion. Dollar General (DG) also reports increases YoY: 10.3% increase in Q3 net earnings from 171 million in 2011 to 208 million in 2012, and an 11.2% increase in the 39-week period to 11.81 billion in 2012. DG clearly shows the most increase in earnings YoY while WMT and TGT are much more comparable level with lower percentages of increase. As we can see, TGT lags competition in growth in the past twelve months, which may contribute to its current valuations. Our price target analysis, however, projects 21.8% growth in operating income over the next five years, and we believe the current value is not representative of a strong growth cycle coming in the next several years.
For the past ten years, TGT has seen a steady increase in its EPS from 1.81 in 2003 to a current EPS at 4.52. TGT's ROA is a solid 6.2%, which falls in the middle of competitors' numbers like Gordman's Stores (GMAN) at 12.5%, Fred's (FRED) at 4.9%, and Dollar General at 9.3%. TGT lands in the middle of competitors when comparing ROE, but it has the lowest ROIC against all these competitors in the industry. TGT reports ROE at 19.1% and ROIC at 7.1%. GMAN, which has the highest numbers across the board, reports ROE at 31.9% and ROIC at 31.3%. DG has stronger numbers than TGT with ROE at 20.0% and ROIC at 11.2%. FRED reports the lowest ROE in the industry with ROE at 7.8% but beats TGT with its ROIC at 7.5%. TGT's ROA, ROE, and ROIC are not the strongest in the market, but it is a healthy company compared to competitors.
As previously stated, TGT generates part of its revenue by offering its customers credit and debit cards. Right now, those credit and debit cards are only offered in the United States. In a recent press release, Target announced that it would be expanding these services to the Canadian market. A customer will be able to automatically link his/her Target Debit Card to one's personal checking account and receive 5% off Target purchases. TGT is expecting to open 124 stores across Canada beginning April/May of 2013. TGT plans to open stores in five cycles, creating 20 to 28 stores per cycle. TGT's CFO Mulligan noted that the company has strategically planned this expansion to transition its supply chain and determine the readiness of its distributors to ensure a smooth process. On March 5, TGT announced that its three pilot stores are open in Ontario, marking the beginning of Target's presence outside the US. The next step of the expansion will be building and opening 24 more TGT stores across Ontario. If these stores are successful, the company can tap into an otherwise completely new source of revenue. Further, success here could suggest potential moves into other similar markets like Mexico, Australia and England. Target has also recently announced different pilot projects to begin expanding its e-commerce presence. The company already has an online store where most of its merchandise is available for purchase but there are two new projects underway: TGT expanded its "shopkick" app from the original seven pilot locations to its entire 1,764 stores, and in February 2013 TGT announced it is one of four companies to partner with Facebook in a program that allows friends to send one another gift balances that can be used at any location on a re-loadable "Facebook" gift card. The Shopkick program rewards TGT customers for different experiences in TGT stores. They earn points for entering the store and scanning items, among other things. These accumulated points can be redeemed in the store.
Economic Moat -
There are many minor aspects of TGT that can contribute to the company's overall uniqueness, but we do not see any one strong characteristic that creates a solid economic moat. One aspect that does provide a small economic moat is the exclusive big-name lines that appear in the apparel and home goods departments. The company's fashion is a definite step above competitors like WMT, COST, DG, and more, and that niche does prove to attract certain customers. Target has partnered with designers like Prabal Gurung in women's fashion or Nate Berkus in home furnishings. These partnerships offer big-name products at affordable prices. These designers change seasonally, allowing for different styles and demographics to be targeted. Some consider this move a negative as it is challenging to keep up with moving trends. Another potential moat is the new TGT concept: City Target. This downtown store is the urbanized version of TGT with increased signage for quicker shopping and commuter-friendly packaging conducive to public transportation. The Seattle, LA, and Chicago City Targets are already up and operational, and plans are in place for new City Targets in Portland and two more in California. While unique celebrity-name brands and cutting-edge City Target stores can create a faithful consumer base, we believe that TGT has a fairly light economic moat overall without strong barriers to entry.
Revenue and EPS Outlook -
TGT saw a slight decrease in sales during Q3 (TGT's holiday season quarter), which suggests that the company needs to expand e-commerce and consumer spending is still modest. The company has also attributed some of this decrease to concentration on the expansion preparation for Canada in spring 2013. Our price target analysis projects 21.8% growth in operating income for TGT by the year 2016. The analysis is also projecting almost 74% potential price appreciation for TGT stock during this same time period. Alongside this forecasted increase in revenue analysts predict that TGT will see its current 4.4 EPS grow to 4.8 by this time next year.
Price Target Analysis
The following price target was configured through a 5-year projected discounted cash flow analysis. The model projects operating income, taxes, depreciation, capital expenditures, and changes in working capital. Using that information, we can project what the company is worth. We can then use that projection and compare it to current prices. Here is how to calculate price targets using discounted cash flow analysis:
Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.
Available Cash Flow
Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012).
PV Factor of WACC
PV of Available Cash Flow
For the fifth year, we calculate a residual calculation. This number is calculated by taking the fifth year available cash flow and dividing by the cap rate, which is calculated by taking WACC and subtracting out residual growth rate. Residual growth rate is typically between 2-6%. 4% is average growth for industry. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. This is why higher growth companies tend to have higher P/E ratios. We will give you cap rate. Cap Rate for TGT: 3.00%
Available Cash Flow
Divided by Cap Rate
Multiply by 2016 PV Factor
PV of Residual Value
Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:
Sum of Available Cash Flows
PV of Residual Value
Interest Bearing Debt
Divide equity value by shares outstanding:
Profit/Value Industry Comparisons
Q1 - Q3 2011
Return on Equity
TGT is showing mostly strong numbers in profitability. Its operating margin and ROE have increased compared to the last fiscal year. TGT's operating margin is a little low at 7.5%, yet it did increase from 6.4% last year. The gross margin has fallen slightly from 30.9% to 30.6%. Finally TGT's ROE increased slightly from 18.9% to 19.1%.
How does TGT compare to the competitors? GMAN is reporting its operating margin at 6.2%, gross margin at 46.0%, and ROE at 38.8%. DG has an operating margin at 9.6%, gross margin at 31.5%, and ROE at 13.6%. Big Lots (BIG) has its operating margin at 2.8%, its gross margin at 39.0%, and ROE at 2.8%. Lastly, FRED has an operating margin at 2.3%, gross margin at 29.4%, and ROE at 7.8%. TGT lands in the middle in a comparison of operating margins, it is second to last on gross margin, and is only second to GMAN in ROE. All in all TGT is maintaining good profitability and stands as a middle road when compared to competitors.
Let's compare TGT to the competitors:
GMAN is operating with a 9.9 P/E and 9.8 future P/E. DG has a 16.7 P/E and a future P/E at 14.0. BIG has a 12.1 P/E and a 10.6 future P/E. Lastly, FRED has a P/E at 15.3 and a future P/E at 13.5. All of these companies, including TGT, show a slight decrease in its projected growth. DG has the highest numbers in this category followed by FRED, which is just slightly stronger than TGT. In comparison to companies in the same sector TGT again proves to have positive numbers that fall the in middle of the spectrum.
A lot of TGT projected value is contingent on increased revenue, which will be coming from profits made off of the expansion project in Canada planned to start this April/May 2013. If this project does not end up as successful as the company is anticipating, this will be problematic. Even so, the plan is set to follow five phases that create 20-28 stores at a time. Problems in construction, suppliers, or distributors could slow down this plan and cost the company in expected revenue. If the Canadian expansion project for TGT in 2013 does not go according to plan or the new stores do not see the reception Target is hoping for from customers, we may not see the stock evaluation we are anticipating.
The Bottom Line
We work to identify healthy companies that show signs of continuing this activity. After careful analysis TGT is an established company that has proved to maintain profitability and shows signs of sustaining those numbers. The most promising aspect of this company's appreciation potential is its large expansion project into Canada. This move will expand TGT's consumer base and bring in previously untapped revenue. We believe TGT is a healthy company that is making proactive efforts to continue achieving high profits, so again we rate this company as a Buy.