How Long Before Target Shakes Off The Discount?

Jul.29.14 | About: Target Corporation (TGT)

Summary

Target still trades at a discount to its top peer, but its growth prospects suggest that discount could soon disappear.

Target has one of the best dividend payments in retail, yielding 3.4% and having been increased for 46 straight years.

A new CEO could lead to a near-term pop in the stock price.

Shares of Target (NYSE:TGT) continue to struggle with the huge data breach the company had earlier this year. It's been both a brand-image problem and a financial one. After posting earnings for the first quarter of 2014 in line with consensus, the retailer cut its second quarter earnings guidance from $1 a share to $0.85. It also lowered full-year 2014 earnings expectations from $3.85 to $4.15 a share to $3.60 to $3.90.

The mixed emotions about the fallout from last year's hacking, where millions of Target customers' credit and debit card info was compromised, are still fresh in shoppers' minds. However, with strides in boosting customers' overall shopping experience, Target could shake off the discount it trades at relative to Wal-Mart Stores (NYSE:WMT).

Expectations for the near future

The big impact of the data breach is brand perception. Some shoppers still fear this could happen again and avoid the store, putting downward pressure on Target's store traffic. But there's also some margin impact due to litigation and compensation costs related to remedying the breach issues -- not to mention costs to beef up security.

Overall, restoring customer confidence will be one of Target's biggest initiatives. Part of that has involved moving to state-of-the-art chip-and-PIN technology from MasterCard and installing the appropriate card readers at all of its stores.

The search for a new CEO is still in full swing. Target's former CEO, Gregg Steinhafel, resigned in May after the company continued to take heat over the data breach. There's been speculation that it could be HSN CEO Mindy Grossman or even Sam's Club CEO Rosalind Brewer. The thing about HSN is that it has annual sales that are less than 5% those of Target.

On the other hand, Sam's Club's business model more closely resembles Target's. Brewer likely has supplier relationships and data/technology knowhow that can be carried over from Sam's Club. Either way, Target investors will likely breathe a sigh of relief when a new CEO is announced, helping signal that Target is ready to leave the credit-breach issue in the past.

The bright spots

Target has been making strides when it comes to becoming an omnichannel retailer. The idea of the omnichannel is to improve customer convenience. This has included implementing in-store pickup.

It recently introduced digital ordering for in-store pickup, which already represents 10% of its total digital business. The beauty of digital order pickups is that these shoppers tend to stay in the store even after picking up their items. Target has found that around one-in-five shoppers spend additional money in-stores when picking up items ordered digitally.

The company also found that these shoppers tend to spend more money than the average shopper. But the real story is that the likes of Target and Wal-Mart are trying to hedge market share losses from Amazon.com.

This is where the two retailers' ship-from-store initiatives come into play. By doing this, the retailers are able to reduce delivery times and cut shipping costs because every store becomes a fulfillment center.

Why buy Target?

Shares of Target are still down 15% over the last year, while Wal-Mart is up 2%. It looks like the comeback for Target will be slow, but in the meantime, investors do get a 3.5% dividend yield. That's well above the 2.5% dividend yield Wal-Mart is willing to pay. Target is expected to grow earnings at an annualized 13% over the next five years (according to Wall Street) compared to its 1% annualized growth over the last five years. Coupling its current P/E and expected earnings growth and its P/E to growth (PEG) ratio you get 1.55 versus Wal-Mart's 1.8.

Target also has the opportunity to right its Canadian operations. Sales in Canada have been lackluster due to a countrywide rollout, which stretched Target's supply chain abilities very thin, leaving stores without needed inventory. One of its key focuses has been on rightsizing this. This, along with the company's continued innovation in the omnichannel, should help put the company on the path to the expected 13% annualized earnings growth over the interim. Assuming Target trades more in line with Wal-Mart on a PEG basis over the interim, the upside is to $69.

Bottom line

Target is still the most attractive stock from a valuation and income perspective in the department store industry. Its dividend should continue attracting income seekers, but for investors who are also interested in value stocks, Target is worth a closer look. It's also tough to find a better dividend yield in the space, at 3.4%, and besting Wal-Mart's 2.5%.

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.