Target Total Return

Target Corp. (NYSE:TGT) July 3, 2009 $37.45 /share
52-week range: $25.00 (Mar. 6, 2009) - $59.55 (Sep. 19, 2008)
Dividend = $0.17 quarterly = 1.81% current yield

Target operates almost 1700 discount retail outlets with combined annual sales of about $65 billion. FY 2008 marked the first down EPS comparison since 1995 with final earnings of $2.86 versus the all-time record of $3.33 set in FY 2007 [FY’s end in January of the following year]. The combined effects of credit-related write-offs and slow economic conditions were responsible for last year’s dip and expectations of flattish earnings for FY 2009.

Zacks now looks for $2.85 and $3.20 for this year and next. TGT shares reflect the reduced numbers while putting Target’s multiples at < 13.2x and 11.7x FY 2009 and 2010 estimates. These are well below their 10-year median P/E of 21x. See the chart below for easy comparison.

Here are Target’s per share numbers (from continuing operations) as reported by Value Line:

A rebound to even 14 times estimates would bring Target shares back to $39.90 by next January and to $44.80 by early 2011. While that’s not enough of a pop to get investors’ juices really flowing, this buy/write combination might do the trick.

If Target shares trade up by at least 5 cents a share over the next 19.5 months:

• The $37.50 calls will be exercised.
• You will sell your shares for $37,500.
• The $37.50 puts will expire worthless.
• You will likely have collected at least $1,020 in dividends.
• You will have no further option obligations.
• You will end up with no shares and $38,520 cash.

The best-case scenario net profit would be $16,270 / $22,250 = 73%, achieved in less than 19.5 months on shares that were virtually unchanged (or anywhere higher) than their trade inception price.

What’s the risk?

If Target shares are still below $37.50 on expiration date in January 2011:

• The $37.50 calls will expire worthless.
• The $37.50 puts will be exercised.
• You will be forced to buy an additional 1000 TGT shares.
• You will need to lay out another $37,500 in cash.
• You will likely have collected at least $1,020 in dividends.
• You will have no further options obligations.
• You will end up with 2000 shares of TGT and $1,020 cash.

What’s the break-even point on the whole trade?

On the first 1000 shares it’s their $37.45 purchase price less the $7.20 /share call premium = $30.25 /share.

On the ‘put’ shares it’s the $37.50 strike price less the $8.00 /share put premium = $29.50 /share.

Your overall break-even would be the average of those prices or $29.88 /share (ignoring dividends) or $28.86 /share (including dividends).

(Already cheap) Target shares could drop by up to $8.59 /share or (-22.9%) without causing a loss on this trade.

Summary:

As long as Target shares edge up to $37.50 or better by January 21, 2011, investors who buy/write as described could see total returns of 73% in fewer than 20 months.

You are protected against loss unless Target declines by more than 22.9%.

Disclosure: Author is long TGT shares and short TGT options.

Comments

[U Dontknow ...:]

Target reported improving margins despite negative SSS for June.

Shares are indicated up almost 5% tp $39 pre-matket.

Jul 09 08:32 AM