As I recently discussed, there are two equities that have been on my radar screen lately. I feel that both offer a reasonable amount of value at today's prices, while they're also likely to see solid growth over the long haul. The more I looked at both of them, the more I really liked what I saw. While I only picked one for now, it's highly likely that I'll add the other one to my portfolio soon.
As part of my Recent Buy series, I try to let my readers know of any equities I purchase soon after the transaction is completed. This is just one way I try to document my progress toward early retirement and financial independence.
I purchased 25 shares of Target Corporation (NYSE:TGT) on 11/15/13 for $66.50 per share. Target Corporation is a retailer that was incorporated in 1902. They currently operate in two segments: U.S. Retail and Canadian. I really like TGT here. They've done some really amazing things over the last couple of years. They've started a fairly massive build-out of new stores in Canada, opening 68 new stores in the country so far this year, which puts them on pace to complete their objective of opening 124 new stores in Canada by year-end. While the company is currently experiencing some dilution in EPS due to the expansion into Canada, the growth should be a tailwind over the long term.
While expanding across the border, they're also expanding into large U.S. cities via their CityTarget stores - which attempt to recreate the suburban shopping experience in a smaller, and more targeted urban format. They currently operate seven CityTarget stores. In all, 2013 is going to be the largest ever single year of store openings, which is quite a feat for a company that was founded in 1902 and currently operates almost 1,800 stores in the U.S. Growth doesn't appear to be slowing.
Meanwhile, Target also continues to invest in its PFresh grocery business. While reducing margins, they also give customers access to a bigger variety of goods and more of a one-stop shopping experience. The company is also aggressively courting shoppers of all income levels, even though Target attempts to differentiate itself from rivals like Wal-Mart Stores, Inc. (NYSE:WMT) with a slightly upscale shopping experience. Target have expanded their Price Match Guarantee to include select online retailers.
Target also completed the sale of their entire consumer credit card portfolio to Toronto-Dominion Bank (NYSE:TD) on March 13 of this year for $5.7 billion. This allows Target to focus on its retailing operations since TD will now underwrite, fund and own future Target Credit Card and Target Visa receivables in the United States. The risk and regulatory compliance falls on the shoulders of TD, while Target will still continue to earn a substantial portion of the profits generated from the credit card portfolio. The two companies have a seven-year program agreement. While Target expects the transaction to be neutral to EPS over time, there may be dilution in the short term. They will use the proceeds from the sale to pay down debt and fund share repurchases - a rather prudent use of cash, if you ask me. I think this sale makes sense as it allows a bank to control the financial aspect of the business, while allowing Target to focus on selling products to consumers. In addition, Target will still see the benefits of returning shoppers as the 5% REDcard rewards still apply and still generate recurring business.
Target has shown an ability to grow. From fiscal years 2004-2013 the company grew revenue at a compound annual growth rate of 4.78%, while EPS has a CAGR of 8.76%. S&P Capital IQ predicts a 12% EPS growth rate over the next three years. This might be a bit aggressive as they have expansion plans internationally and domestically which will dilute EPS in the short term. However, I think over the long haul this upscale retailer should do very well as all of the moves the company is making now are not meant for success over the next year or two, but for decades. The company itself is targeting more than $100 billion in sales and $8.00 or more in EPS by 2017.
Target shares are currently priced at a TTM P/E ratio of 16.1 on EPS of $4.15. That gives shares a yield of 2.57% off a quarterly dividend of $0.43. That yield is not especially appealing by itself, but it's backed by a long history of outstanding growth. The 10-year dividend growth rate of TGT shares is 18.6%, with a most recent dividend increase of 19.4% back in June of this year. The dividend is also well covered with a payout ratio of just 41.4%. They are not just returning capital to shareholders via an aggressive dividend growth policy, but also through share buybacks - repurchasing 21.9 million shares at an average price of $67.41 year-to-date. They've been heavily active in share buybacks for years, reducing total outstanding shares from almost 755 million in 2009 to just over 633 million today. The balance sheet appears attractive with a debt/equity ratio of 0.8.
I think Target is making all the right moves right now. There might be some short term pain for long term gain as many of the aggressive expansion efforts domestically and abroad aren't cheap, but I think shareholders should be amply rewarded looking out over the next 5-10 years. Paying down debt and repurchasing shares with the proceeds from the sale of the credit card portfolio, while also reducing riskier credit card receivables exposure shows management is prudent, and I give these moves a thumbs-up. Furthermore, I like the fact that the company is focusing on its retailing efforts seeing as how competition is extremely fierce. Retailers typically operate with low margins and are under constant duress from competition, so it's extremely important to leverage scale and differentiate oneself from others. I think Target does a great job at this with an upscale atmosphere, new urban experiences, free Wi-Fi in all of its stores, a healthy reward system via the REDcard and their Price Match Guarantee.
Of course, even great companies aren't worth owning at any price. I valued shares with a typical Dividend Discount Model analysis using a 10% discount rate and a long-term 8% growth rate (well below their historical average). This gave me a fair value of $92.88. I think a decent margin of safety exists here at today's prices.
This purchase adds $43.00 to my annual dividend income based on the current quarterly payout of $0.43. This is now the 43rd position in my portfolio, as this was a new investment for me. I'm going to include current analyst valuation opinions below, as I use these to concentrate my reasonable valuation estimate.
*Morningstar rates TGT as a 3/5 star value, with a fair value estimate of $64.00.
*S&P Capital IQ rates TGT as a 4/5 star Buy, with a fair value calculation of $73.20.
I'll update my Freedom Fund in early December to reflect my recent addition.
Disclosure: Long TGT, WMT, TD