Target: A Promising Company At A Discounted Price

Jun.30.14 | About: Target Corporation (TGT)

Summary

Target possesses many positive qualities that have recently been overshadowed by temporary obstacles.

Target's attractive qualities include a strong brand image, a focus on becoming an effective omni-channel seller, and a consistent return of profits to shareholders.

Target's current problems include the well-known data breach, an unsatisfactory entry into the Canadian market, and uncertainty in top management, but are unlikely to affect long-term performance.

Target's (NYSE:TGT) stock price has been trending downwards over the past year, which could present a buying opportunity. Beneath all the recent challenges and uncertainty the company has faced, there are many positives that may not have been given appropriate weight.

Target has a strong brand image. Target stores are clean, modern, and provide customers with a pleasant shopping experience. The company's priorities and business strategy are embodied in its tag line, "Expect More. Pay Less." Target strives to provide its "guests" with an enjoyable shopping experience, while offering products at reasonable prices. Stores offer a variety of products, including household essentials, electronics, apparel, food, and home furnishings. Target has built customer loyalty with its "REDcard", which allows cardholders to receive 5% off of all purchases and to get free shipping from its website. Target has a strong overall business strategy, but there are several other factors to take into consideration.

Focus on the Digital Marketplace

Target is striving to become an effective omni-channel seller by increasing online and mobile sales. During its 1Q 2014 earnings call, management reported that 1Q'14 digital visits were up more than 20% from the prior year, which was a much greater increase than that of major competitors. During the call, management conveyed an increased focus on building Target's online presence.

In mobile, Target's app, Cartwheel, has attracted over 7 million users since its release last year. The app offers discounts on selected items, and active users have increased their trips and spending at Target by nearly 30%. The company now has nearly all in-store products available online, in addition to selections that are only available on its website. With management focused on the digital side of its business, Target can continue to be competitive, as consumers' everyday purchases are increasingly made over the internet.

Consistent Return to Shareholders

Target is great at returning profits to shareholders. Target currently has a dividend yield of about 3.6%, and has impressively increased its quarterly dividend for 47 straight years. Over the past 10 years, Target has averaged just over 20% dividend growth. Target takes great pride in its dividend payout policy, and while the company may not sustain 20% growth in dividends forever, we will likely see continued dividend growth for many years to come.

Target has also been actively repurchasing its stock. As of the company's most recent annual report, the company had authorized a stock buyback program of $5 billion of common stock, with $1.9 billion of that remaining. During the first quarter of 2012, Target completed a separate $10 billion share repurchase program that began in November 2007.

Companies that consistently pay out growing dividends tend to outperform those that don't. Target's dividend and stock repurchase policies illustrate that the company is committed to returning profits to shareholders.

Challenges

The challenges that Target is facing, including the well-known data breach, a poorly executed entry into Canada, and uncertainty in management are likely temporary issues that have given way to a good buying opportunity.

Data Breach

The data breach in November-December 2013 resulted in stolen payment card data from 40 million credit and debit card accounts, and additional stolen personal information from 70 million individuals. This resulted in a meaningful decrease in sales in the following quarter, and hurt the company's image. However, sales have been gradually increasing towards pre-breach levels, and the company's image is being slowly restored. The company has planned a capital investment of about $100 million to add chip enabled smart-card technology to its proprietary REDcards to increase card security. The data breach has been one of the main drivers for Target's recent stock price decline, but this was likely an isolated incident, providing a lower price to purchase the stock as a long-term investment.

Canadian Market

Target's entry into the Canadian market has been another driver for the stock price's decline. The company opened 124 new stores in Canada in 2013, far exceeding the 17-18 new stores typically opened in the U.S. every year. The Canadian segment's 2013 gross margin was 14.9%, compared to the U.S. gross margin of 29.7%. Canada has only a tenth of the population of the United States, and the country's population is more spread out, which makes it difficult for Canadian stores to offer the same range of selection that U.S. locations can. Canada also has higher labor and real estate costs, which drive up product prices. This was a particularly unpleasant surprise for Canadian customers accustomed to crossing the border to shop at U.S. Target stores that offer lower prices.

While the initial Canadian results are disappointing, it is unlikely that the situation will get worse. Results will either improve over time or, worst case, the initiative will be abandoned. On the plus side, the Canadian stores that have been open the longest are the most profitable, suggesting that Target stores are adapting to the Canadian marketplace. If Target is able to get its act together in Canada, it will have access to a new market that offers great growth potential for the company.

Management Changes

Target has suffered from problems in upper management. A recent Wall Street Journal article describes how conflict among management caused Target to adapt to trends too slowly and to suffer a loss in creativity. Last May, after a great deal of internal conflict, the CEO, Gregg Steinhafel, resigned, and the company is currently being headed by an interim CEO. While this situation causes greater uncertainty, it also presents Target with an opportunity to transition into a new phase, with management focused on new initiatives and changing the company for the better. Recently, the company has shown signs of trying new strategies, including adding mannequins to some of its stores and becoming much more aggressive with its online presence. Target is taking its time in finding the ideal person to take over as chief executive. Once it finds the right person for the job, uncertainty will be decreased and Target will be able to continue moving in a positive direction.

Conclusion

Target has recently suffered from the data breach, a poor entry into Canada, and changes to upper management. However, these problems seem to be temporary, and the company's stock price should go up as these problems get resolved. Going long on a stock when short-term problems arise is a classic contrarian move. Although being contrarian just for the sake of being contrarian is not always the right move, I believe that in this case, it is the correct play. Target has several factors going in its favor, including a powerful brand, impressive online growth, and a favorable dividend payout policy. This could be just the right time to go long TGT.

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.