Target's New Dividend Policy Is Attractive And Sound

Jun.30.14 | About: Target Corporation (TGT)

Summary

Target recently raised the quarterly dividend to $0.52.

The author concludes that the dividend is safe for the next two years, despite competition from Amazon, and the potential for losses from the data breach.

The 3.6% current yield is attractive, especially when considering the strong 2.3x dividend coverage ratio.

The scope of this article will look at a large retailer, Target (NYSE:TGT), which I feel is suffering from competition with Amazon (NASDAQ:AMZN). I won't touch on the data breach, which affected the company during the 4th quarter of last year. My goal is to understand the ability of Target to pay the new $0.52 per quarter dividend announced in early June 2014.

How Safe is the Dividend?

Cash flow summary ($ in millions)

3 Months ending 5/3/14

FYE 2/1/14

FYE 2/2/13

Cash from operations

$520

$6,520

$5,325

Capex

($561)

($3,453)

($3,277)

Proceeds on sale of accounts receivable originated at Target

0

$2,703

0

Dividends (actual amount)

($272)

($1,006)

($869)

Repurchases of common stock

0

($1,461)

($1,875)

Click to enlarge

The cash balances at 5/3/14 was $715 million. The company recently raised the dividend to $2.08 per share annually, or $0.52 per quarter/share. Given about 638 million shares outstanding at 5/3/14, this amounts to $1,327 million annually, or $332 million per quarter for the dividend.

For FYE 2/1/14, Target generated $3,067 million in adjusted free cash flow, or cash from operations minus capex. To calculate the dividend coverage ratio, we must adjust for the annual dividend payment of $1,327 million (reflecting the dividend of $2.08 per year). The dividend coverage ratio is the free cash flow over the dividend, or 2.3x.

Some readers may question why I do not adjust the FYE 2/1/14 cash from operations ($6.5 billion) lower by the amount of the proceeds on the sale of accounts receivable originated at Target ($2.7 billion). This is because management intended to sell the credit card portfolio, as it was not a core competency. The proceeds from the sale were partially invested into the Canadian retail operations. It could also be argued that the Capex figure going forward will be lower as the Canadian operations will require lower capital expenditures once the footprint and construction are complete. I will revisit these issues for Target later in the fiscal year as more financial data is available.

For more comparisons on other large cap dividend coverage ratios, see this article on AT&T (NYSE:T) or this article on Starbucks (NASDAQ:SBUX). Please note that Starbucks had a dividend coverage ratio of 3.3x for the most recent six months of operations, and I concluded that this dividend would be raised in the next couple of months.

Some Thoughts about Amazon

I recently explored AMZN and a financial ratio known as the Cash Conversion Cycle.

I concluded that AMZN gets to hold on to more of their supplier's cash, effectively borrowing it from suppliers. By sitting on a supplier invoice for an additional three weeks, AMZN has an incredible source of cash when multiplied over $74 billion in annual sales. For AMZN, Accounts Payable is an unencumbered source of value, and it comes without any interest costs. AMZN can dictate terms to suppliers, and then invest the float in other projects. However, for many investors and analysts, it is unclear whether AMZN is reinvesting the float into profitable projects!

Has the AMZN Competitive Pressure Hurt Target?

3 Months ending 5/3/14

FYE 2/1/14

Amounts in Millions of $

$17,050

$72,596

Revenues

$1,185

$1,347

Receivables (from Pharmacy, income taxes, and vendor income receivables)

This receivable figure wasn't broken out on the Q1 financial statement, so the same 64% of current assets, which were receivables at FYE 2/1/14 was applied to the $1.9 billion current asset figure at 5/3/14.

6.3

6.8

(A) Days receivables {(Receivables/Sales)*365 days for full year or 91.25 for 1/4 year}

3 Months ending 5/3/14

FYE 2/1/14

$12,067

$51,160

Cost of sales

$8,450

$8,766

Inventory

63.9

62.5

(B) Days inventory {(Inventory/Cost of Sales)*365 days for full year or 91.25 for 1/4 year}}

$12,067

$51,160

Cost of sales

$6,793

$7,683

Accounts payable

51.4

54.8

(C) Payable Days {(Payables/Cost of Sales)*365 days for full year or 91.25 for 1/4 year}}

18.9

14.5

Cash conversion cycle {a+b-c}

Click to enlarge

I did not include the FYE 2/1/13 financials because Target owned a large credit card portfolio (resulting in large receivables), and that would have skewed the cash conversion rates.

The cash conversion cycle is the amount of time between a company spending cash and receiving cash per each sale. It is a measure of efficiency and how long cash is tied up in working capital.

Remember, in this article, I show the Cash Conversion Cycle for AMZN as negative. The above chart shows that TGT has tied up cash in inventory for more than 2 months of operations, which resulted in a worse cash conversion cycle when compared to AMZN. In 2013, AMZN held inventory for 37 days plus 23 days to collect receivables or 60 days in total. AMZN pays accounts payable in 74 days, thus achieving a negative cash conversion cycle.

Conclusion

Despite the stiff competition from Wal-Mart (NYSE:WMT) and Amazon, I continue to find shares of TGT attractive. I shop there regularly and find the selection adequate for my needs.

TGT recently raised the dividend to $2.08 per year, which amounts to a 3.6% current yield. I feel that this dividend is safe for the next 2 years. I also surmise that the company would not raise the dividend if the data breach occurring in late 2013 was a giant financial black hole requiring large amounts of management time and shareholder capital.

Please note that the intention of this article was not to analyze the financial repercussions of that data breach, and investors must do their due diligence on this aspect of Target.

This article is the opinion of the author and does not represent investment advice.

Disclosure: The author is long DIS, TGT. 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.