Target (NYSE:TGT) and Wal-Mart (NYSE:WMT) are two of the nation's largest big box retailers. Both companies have had weak financial results in their latest quarters. Wal-Mart and Target are both Dividend Aristocrats with a long history of growing dividends and earnings.
Which company is a better buy now for long-term dividend growth investors? This article will find the answer using the 5 Buy Rules from the 8 Rules of Dividend Investing, along with a qualitative analysis of both companies' current events and future growth potential.
Target Current Events
Target suffered a data breach at the end of 2013, in which the personal information of 70 million shoppers was stolen. The company's sales were negatively impacted by the breach. Target is switching to chip and PIN technology for its debit and credit cards to mitigate future data breaches. The company is committing $100 million to the upgrade, which will roll out by early 2015.
Source: International Business Times
Target CEO, Gregg Steinhafel recently resigned. The company is actively searching for a new CEO. In the interim, Target's CFO, John Mulligan will stand in as the company's CEO. Gregg Steinhafel mentioned in his resignation letter that the company has recently faced difficulties, including "a slow Start in Canada and the 2013 data breach." Gregg Steinhafel also stated in his resignation letter that "now is the right time for new leadership at Target." A favorable change in CEO could give Target stock a boost, in light of the recent troubles the company has faced under current management.
Target has opened over 100 Canadian locations in recent years. The expansion has not gone as well as planned. Gross margin in Canadian stores is currently around 18%, and is expected to hit 20% for the second quarter of 2014. This is significantly below the company's US gross margin rate, which has been around 30% for the last 4 years. To achieve profitability in Canada, Target must raise its gross margin to at least 25%. The Canadian expansion has negatively impacted earnings and cash flow.
Source: Target First-Quarter Transcript
Target Growth Potential
Despite Target's recent weakness, the company has long-term growth potential. Target is not in immediate danger of losing its competitive advantage. The data breach and slow Canadian sales do not affect Target's core business model of low-priced goods sold at clean, upscale stores.
Target posted slight US stores revenue growth for the first quarter of 2014 as compared to the first quarter of 2013. The company has successfully rebounded from its disastrous fourth-quarter sales results, which were negatively impacted by the data breach.
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Source: Target Quarterly Store Sales Change
Target also expects to grow revenue 25% from the first quarter of 2014 to the second quarter of 2014 in its Canada locations. The company is slowly gaining traction in the Canadian market as gross margins and sales continue to rise. When Target's Canada expansion begins to add to the company's bottom line, Target will see a meaningful boost to its earnings per share.
Source: Target First-Quarter Transcript
Target generates enormous cash flows. The company has managed to buy back an average of 4.5% of its shares each year over the last 4 years. Shareholders of Target were recently given a dividend increase of about 20% as management continues to distribute cash flows to shareholders.
Wal-Mart Current Events
Wal-Mart grew constant currency sales 2.1% for the first quarter of 2014. Same-store US sales were down 0.1% due to a small decline in traffic. Sam's Club fared only slightly better, with sales growing less than 1% on a quarter-over-quarter basis.
Wal-Mart grew international constant currency sales 3.4% for the first quarter of 2014 versus the first quarter of 2013. Operating income increased 5.3% in the international segment, outpacing sales growth. Wal-Mart is improving operating efficiency internationally, as revenues are increasing.
Source: Wal-Mart First-Quarter Results
Wal-Mart Growth Potential
Wal-Mart's future growth will be driven through further international expansion. The developing world is growing faster than the developed world. Wal-Mart US sales are growing slowly due to the competitiveness of the market.
Wal-Mart has not reached the level of market saturation in the developing world as it has in the developed world. The company's first-quarter results show that Wal-Mart is able to grow revenues per share internationally, while increasing operating margins. The company currently generates about 30% of its revenues internationally.
Buy Rule Comparison 1: Dividend History
Wal-Mart has increased its dividend payments for 41 consecutive years. Target has increased its dividend payments for 44 consecutive years this year. Both businesses have 4-plus decades of yearly dividend increases, which show that both companies can grow profitably over very long time periods.
Why it matters: The Dividend Aristocrats (stocks with 25-plus years of rising dividends) have outperformed the S&P 500 over the last 10 years by 2.88 percentage points per year.
Source: S&P 500 Dividend Aristocrats Factsheet, February 28 2014, page 2
Buy Rule Comparison 2: Dividend Yield
Target has a dividend yield of 3.56%, the 18th-highest yield out of 128 businesses with 25-plus years of dividend payments without a reduction.
Wal-Mart has a dividend yield of 2.55%, the 55th-highest yield out of 128 businesses with 25-plus years of dividend payments without a reduction.
Why it Matters: Stocks with higher dividend yields have historically outperformed stocks with lower dividend yields. The highest-yielding quintile of stocks outperformed the lowest-yielding quintile by 1.76 percentage points per year from 1928 to 2013.
Source: Dividends: A Review of Historical Returns
Buy Rule Comparison 3: Payout Ratio
Target has a payout ratio of 70%, the 104th-lowest payout ratio out of 128 businesses with 25-plus years of dividend payments without a reduction.
Wal-Mart has a payout ratio of 40%, the 42nd-lowest payout ratio out of 128 businesses with 25-plus years of dividend payments without a reduction.
Why it Matters: High-yield, low-payout ratio stocks outperformed high-yield, high-payout ratio stocks by 8.2 percentage points per year from 1990 to 2006.
Source: High Yield, Low Payout by Barefoot, Patel, & Yao, page 3
Buy Rule Comparison 4: Growth Rate
Target has a revenue per share growth rate of 7.56% over the last decade, the 26th-highest out of 128 businesses with 25-plus years of dividend payments without a reduction.
Wal-Mart has a revenue per share growth rate of 8.23% over the last decade, the 19th-highest out of 128 businesses with 25-plus years of dividend payments without a reduction.
Why it Matters: Growing dividend stocks have outperformed stocks with unchanging dividends by 2.4 percentage points per year from 1972 to 2013.
Source: Rising Dividends Fund, Oppenheimer, page 4
Buy Rule Comparison 5: Volatility
Target stock has had a standard deviation of 30% over the last decade, the 76th-lowest out of 128 businesses with 25-plus years of dividend payments without a reduction.
Wal-Mart stock has had a standard deviation of 19% over the last decade, the 11th-lowest out of 127 businesses with 25-plus years of dividend payments without a reduction.
Why it Matters: The S&P Low Volatility index outperformed the S&P 500 by 2 percentage points per year for the 20-year period ending September 30th, 2011.
Source: Low & Slow Could Win the Race, page 3
Wal-Mart has a significantly lower payout ratio, higher growth rate and lower volatility than Target. Target has a higher dividend yield, but the company's P/E ratio is about 20, versus about 16 for Wal-Mart.
Wal-Mart is growing international sales profitably, while Target has floundered in Canada. Target's Canadian expansion will likely turn around and add to the company's bottom line. Wal-Mart's ability to expand internationally has been proven over the last several years. Wal-Mart has a long growth runway ahead of it internationally, while Target's ability to expand beyond North America is unknown.
Wal-Mart is a Top 10 stock, based on the 8 Rules of Dividend Investing, and a buy, while Target is in the Top 40, and ranks as a hold. Both businesses have a long history of rewarding shareholders and will likely continue to do so through dividends, share repurchases and organic growth.
Disclosure: The author is long WMT. 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.