Dividend Buy Of The Month: Target Corporation

| About: Target Corporation (TGT)

I wrote recently about three reasonably priced stocks in today's elevated stock market. While drafting the article and researching some of the companies therein, I decided to purchase additional equity in one of these companies after yet another drop in the price shares commanded on the open market this past Friday.

This drop is fairly warranted, as I'll discuss below. However, it's important to remember that while it's easy to purchase stocks when euphoria is widespread, it's much more difficult to invest in a company when it's facing issues or it's unpopular for any myriad of reasons.

I purchased 25 shares of Target Corporation (NYSE:TGT) on 1/10/13 for $62.50 per share.

Target Corporation is a retailer that was incorporated in 1902. It currently operates in two segments: U.S. Retail and Canadian. I've talked about Target a lot around here lately, and that's because I think it's doing a lot of things right for the long-term, while also facing a lot of near-term uncertainty which is causing its share price to flounder. In addition, the company recently became the victim of a massive data breach when hackers stole the data and credit card information of 70 million customers.

Shares in Target have not done particularly well over the last year, up only about 4% when the broader market is up some 30%. However, it's exactly this kind of underperformance that sparks my interest as a value investor.

The share price weakness is warranted due international expansion in Canada getting off to a slow start. Apparently, customer volume has been promising, but higher-than-expected prices and issues with merchandise stock have left a sour taste in the mouths of some Canadian shoppers. The slower start in Canada has forced Target to slash full-year guidance and has led to EPS dilution. After third quarter results came in weaker than expected, TGT shares fell fairly precipitously and haven't really recovered since. And then, shortly thereafter, the news about the data breach broke.

Combine these two issues and you have the recipe for a stock sale. However, I don't think either of these will result in long-term problems for the company. Issues like a data breach aren't typically remembered a year or two after they happen, and as long as Target can make sure this isn't a recurring issue I think they'll be fine. Case in point: remember the theft of data from 45 million credit and debit cards that The TJX Companies, Inc. (NYSE:TJX) reported back in 2007? Neither do I. In addition, I anticipate the stores in Canada eventually becoming a bigger part of the story as the company does a better job stocking shelves and figures out marketing strategies to best align the experience they offer with shopper's needs.

While TGT shares aren't especially cheap here, I think they offer a fairly decent value for the long-term investor. And while I expected the drop in share prices to be even more aggressive after the data breach news came out, I'll take the opportunity to purchase cheaper shares when I can get them - especially in a hot stock market like we have right now. I initiated a position in Target back in November for $66.50 per share, so I was fairly excited to see TGT take a hit and give me the chance to average down on my purchase price.

And while TGT shares aren't particularly popular right now, the fact is that they're still a great retailer that offers shoppers a unique, upscale experience with a specialty in home goods and chic-for-less. And the assets they're building out in Canada aren't going to go away. These are high quality assets in relatively affluent and populous areas like Toronto and Vancouver. And let's not forget, this is still new for Target. I don't think any business expects to expand into an unfamiliar area and just start dominating right out of the gate. These plans take time, and luckily as a long-term investor I've got that in spades. In the meanwhile, I'm paid to wait with a 2.75% yield and Target gets to repurchase shares at cheaper levels, thereby increasing my ownership stake even further.

This purchase doubled my stake in Target, and puts it on a similar weighting with my position in the other retailer I've invested in - Wal-Mart Stores, Inc. (NYSE:WMT). Going forward, I think having an equal weighting in both companies makes sense for me as they both offer compelling but different reasons for investment.

Target is currently trading hands for a P/E of 16.80. The debt/equity ratio is reasonable at 0.8. The company has a track record of operational excellence, with an EPS compound annual growth rate of 8.76% from fiscal years 2004-2013. S&P Capital IQ is predicting 8% CAGR in EPS over the next 3 years, which is similar to what the company has been able to achieve over the last decade. Target has been great about rewarding shareholders, with both buybacks and dividend raises. The company boasts a 46-year dividend growth record, with a 10-year dividend growth rate of 18.6%. With a payout ratio of just 43% on lower earnings, I think the company has plenty of ammo with which to continue raising the dividend. And the buybacks have been robust, reducing share count from almost 755 million in 2009 to just over 633 million today.

I performed a Dividend Discount Model analysis on shares to get a quantitative take on the valuation. I used a 10% discount rate and a long-term 8% growth rate (well below the historical norm), which gave me a fair value on shares of $92.88. Slowing the growth rate down further to 7%, you get a fair value of $61.35. So obviously you have to hope the company is able to continue growing earnings and the dividend at a rather robust rate, but I think the truth probably lies somewhere in the middle of these numbers.

This purchase adds $43.00 to my annual dividend income total based on the current quarterly payout of $0.43. My portfolio still holds 43 positions, as this was an addition to a current investment. 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 3/5 star Hold, with a fair value calculation of $70.50.

I'll update my Freedom Fund in early February to reflect my recent addition.

Disclosure: Long TGT, WMT