Target: A Much-Needed Dividend Increase

Jun.12.14 | About: Target Corporation (TGT)

Summary

The retailer injects some much-needed confidence into its investors.

Trading at the low end of its 52-week range, Target's yield handily beats Wal-Mart's.

Its payout ratio, free cash flow, and earnings should comfort investors about many more dividend increases.

Target Corporation (NYSE:TGT) really needed a big dividend increase after the disastrous credit card breach. And boy, did the company deliver. Target has just announced a massive 21% increase to its dividend, and it seems like investors are pretty happy about it, as can be seen here on Seeking Alpha's coverage of the same.

This article evaluates Target Corporation's dividend fundamentals. Let us get into the details.

New Yield: The new annual dividend of $2.08 gives Target a current yield of 3.60%, which handsomely beats Wal-Mart Stores' (NYSE:WMT) yield of 2.50%. Investors might also recall that Wal-Mart's latest dividend increase was a bit disappointing, although Wal-Mart has a history of catching up.

Payout Ratio: Target's payout ratio now stands at 70%, based on trailing twelve-months' EPS of $2.96. Target's forward payout ratios looks much more reasonable at 56% and 48%, based on 2014's earnings estimate of $3.69 and 2015's $4.32 respectively. As a comparison, Wal-Mart's current payout ratio stands at about 40%.

Dividend Growth: Target has been paying dividends for more than 3 decades, but this stock is rarely discussed when talking about venerable dividend growth stocks. The table below shows the 5-year dividend growth history, and the numbers speak for themselves. The average dividend growth rate has been a staggering 25%.

(Source: Yahoo Finance)

Free Cash Flow:

  • Target has a total of 634 million shares outstanding.
  • The average quarterly free cash flow [FCF] over the past 5 years stands at $648 million.
  • At the current dividend level of 52 cents/share/qtr., Target is committing $329 million (634 million times 52 cents) to shareholders.
  • Target's quarterly free cash flow has been above this $329 million amount in 13 out of the last 20 quarters.

Extrapolation: The table below shows the potential yield on cost for investors who are willing to set aside their money with Target. The table assumes a 10%/yr. dividend growth for the first 5 years and 7%/yr. for the next 5 years. The yield on cost more than doubles, as can be seen below.

The assumed dividend growth rates pale in comparison with what Target has managed over the last 5 years, but it does not hurt to be conservative. We must also keep an eye on the expanding payout ratio.

(Source: Current dividend and share price from Yahoo Finance)

Forward Looking Analysis and Conclusion:

  • Morningstar has a fair value estimate of $65, which represents 14% upside from the current level of $57.
  • Earnings are expected to grow at 12%/yr. over the next 5 years, and the stock is trading at multiple of 15, based on 2014's estimate of $3.69.
  • Even if earnings come in at half the expected rate of 12%, the EPS will be at least $4.00/share in 5 years. If Target maintains the current payout ratio of 70%, investors will be looking at an annual dividend of $2.80. That would represent a 35% increase in dividend from the current level.
  • Bottom line is, trading at the lower end of its 52-week range, Target is presenting an interesting mix of value, yield, and dividend growth potential. With the latest dividend bump, this stock might be the best bet in the variety stores industry.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.