Target Corporation (TGT) is a best of breed among department stores and should continue to provide investors with strong cash returns and capital gains. The next week presents three major events for the shares and near-term risk could outweigh the rewards. Investors may want to wait until next week to buy shares or hedge current positions against a near-term downside.
On Target against other big-box retailers
Though Best Buy (BBY) has taken the spotlight with its 250% return over the last year, Target has outperformed most others in the space. Over the last five years, the company has done especially well against other big-box department stores like J.C. Penney (JCP) and Sears Holding (SHLD).
An operating margin of 7.3% at Target is close to the highest in the industry, well above 5.9% at Wal-Mart (WMT) and negative margins at both Sears and JC Penney. The company's return on assets of 7.3% is just below Wal-Mart but still above peers.
Despite the worst economic recession in more than 100 years and a brick-and-mortar sales environment that has caused bankruptcies at established companies, Target has managed eight consecutive years of sales growth and a compound annual rate of 3% over the last five. Target is a best of breed in the department store space and could be the last man standing over the long-term.
Retail Sales, Earnings and Black Friday
Despite the long-term outlook, this week presents some major challenges to the shares. Any one of the three could cause a sharp drop in the stock price.
Retail sales for the month of October are due out at 8:30am on Wednesday. The decline of 0.1% in September was largely the result of a 2.2% drop in motor vehicles while most other categories did fairly well. More important for Target is the trend in the clothing category which fell for the last two consecutive months.
October sales will include the effects of the government shutdown and could show that consumers held off on spending. A weak report just before the kick-off to the holiday season could hit retailers in two ways. First, hitting consumer confidence and lower sales, and second as retailers cut prices even more to grasp at the few remaining sales. Within the sales report, I would pay more attention to the clothing category as a predictor of the company's earnings and the larger holiday trend. If the category shows a rebound in October then investors may leave their positions uncovered through earnings.
Target is scheduled to release earnings before the market opens on Thursday. The retailer is expected to post $0.63 per share on sales of $17.4 billion, representing sales growth of 3% over the same period last year. The company has generally beaten expectations in the past and estimates have come down from $0.88 in the last 90 days.
While Best Buy beat earnings expectations when it reported Tuesday, it missed estimates for sales and shares plunged more than 10%. The company was only able to meet third quarter earnings estimates by drastically reducing expenses, and CEO Hubert Joly warned that holiday sales could be weaker than expected on margin pressure as price competitiveness ramps up.
In the previous quarter, sales at Target increased by 2.4% while expenses for selling, general and administrative increased at a faster 2.9% rate. This may indicate that the company has not done as good a job cutting expenses as peers and cost-cuts may not save earnings on a weak sales environment. Of the three events this week, I would be most concerned around the earnings report on a weak release or weak guidance for the fourth quarter.
Black Friday and the early holiday price competition among retailers this year rounds out the near-term risks. According to ShopperTrak, holiday spending is forecast to increase just 2.4% over last year as sluggish wage growth and consumer confidence weighs on the holiday spirit. With lowered expectations on sales growth this season, it appears that Wal-Mart is planning a dangerous race to the bottom. The mega-retailer has announced that it will match Black Friday prices in competitors' ads starting Friday, November 22nd. Wal-Mart has already begun a Christmas Ad Match program on its website that reimburses customers the difference on products advertised at local brick-and-mortar competitors with gift cards.
If Wal-Mart's campaign is successful in gaining market share this late in the season, competitors will need to slash prices in response or get stuck with the inventory. Either way, the industry faces lower sales and margins going into the most important time of the year.
Price to sales is my preferred metric on retailers and Target is right at the industry average at 0.60 times trailing annual sales on a per share basis. While the troubled companies like Sears (0.17 times) and JC Penney (0.16) are trading at discounts, Wal-Mart trades only slightly cheaper at 0.54 times sales. With my best of breed thesis on Target, I do not mind paying a little more and would think the shares could command a higher premium.
Management has made the commitment of returning cash to shareholders and dividends per share have increased by an annualized 22% over the last five years. The company has bought back an average of $1.8 billion in stock each year of the last five and the share count has decreased by an annualized 3.4% over the last decade.
The consensus is for an increase of just 0.4% in sales this year to $73.6 billion. Despite pricing pressures, I am looking for the company to beat marginally for $74.1 billion and $116.70 per share. With a price multiple of 0.6 times, I am setting a target of $70.02 over the next two quarters and a dividend increase next year to $1.96 per share on an annual basis.
My price target provides for a 5% increase plus a 3% dividend yield, lower than the market gains this year but it may prove to be attractive so late in the bull market. As a best of breed, I believe the shares also offer good long-term value but would hedge around the major events of the week. Investors may want to take their initial cue off of the retail sales report before heading into earnings. The shares did not fall on Tuesday with Best Buy's holiday warning so there could still be a surprise if management guides lower.