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Summary

  • Target has had a rough go of it over the past year, and shares have languished.
  • A recent guidance cut underlies operational issues.
  • Target's yield and value should serve to buoy shares on pullbacks.

Target (NYSE:TGT) has been the butt of many jokes among investors this year, as the company struggled with the famous data breach and lagging sales, in addition to replacing its CEO. This would be quite a busy year for any company, and Target has managed to marry all of that excitement with disappointing operational results as well, seeing shares fall from their highs of $70 last year to less than $58, where they trade as I write this. The question for investors is if there is any value in TGT at $58 or if there is further to fall. In this article, we'll attempt to answer that question.

(click to enlarge)

To do this, I'll use a DCF-type model that you can read more about here. Basically, the model uses inputs such as earnings growth rates, which I've sourced from Yahoo, dividends, which I've set at 6% growth annually, and a discount rate, which I've set at the 10-Year Treasury rate plus a risk premium of 7%, reflecting Target's operational issues and elevated risks going forward. Had Target not had so many negative catalysts in the past year, I would've chosen a lower discount rate. However, investors must be compensated for the additional risk.

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

Prior Year earnings per share

$3.25

$3.50

$4.10

$4.62

$5.20

$5.86

x(1+Forecasted earnings growth)

7.70%

17.10%

12.66%

12.66%

12.66%

12.66%

=Forecasted earnings per share

$3.50

$4.10

$4.62

$5.20

$5.86

$6.60

Equity Book Value Forecasts

Equity book value at beginning of year

$26.02

$27.44

$29.33

$31.61

$34.34

$37.57

Earnings per share

$3.50

$4.10

$4.62

$5.20

$5.86

$6.60

-Dividends per share

$2.08

$2.20

$2.34

$2.48

$2.63

$2.78

=Equity book value at EOY

$26.02

$27.44

$29.33

$31.61

$34.34

$37.57

$41.39

Abnormal earnings

Equity book value at begin of year

$26.02

$27.44

$29.33

$31.61

$34.34

$37.57

x Equity cost of capital

9.50%

9.50%

9.50%

9.50%

9.50%

9.50%

9.50%

=Normal earnings

$2.47

$2.61

$2.79

$3.00

$3.26

$3.57

Forecasted EPS

$3.50

$4.10

$4.62

$5.20

$5.86

$6.60

-Normal earnings

$2.47

$2.61

$2.79

$3.00

$3.26

$3.57

=Abnormal earnings

$1.03

$1.49

$1.83

$2.20

$2.60

$3.03

Valuation

Future abnormal earnings

$1.03

$1.49

$1.83

$2.20

$2.60

$3.03

x discount factor(0.095)

0.913

0.834

0.762

0.696

0.635

0.580

=Abnormal earnings disc to present

$0.94

$1.24

$1.39

$1.53

$1.65

$1.76

Abnormal earnings in year +6

$3.03

Assumed long-term growth rate

3.00%

Value of terminal year

$46.67

Estimated share price

Sum of discounted AE over horizon

$6.76

+PV of terminal year AE

$27.07

=PV of all AE

$33.83

+Current equity book value

$26.02

=Estimated current share price

$59.85

As we can see, the model produces a fair value of around $60, or just over $2 higher than the shares trade for as I write this. This would indicate that Target is a good value right now and offers a moderate margin of safety in terms of value. So should we run out and buy?

Perhaps. But before we make any decisions, we need to dig a bit deeper and understand what we're looking at. The model produces a fair value, which is different from a price target. The fair value I've computed is in reference to today's price, and not some point in the future, as would be the case with a price target. Basically, instead of multiplying some out year's earnings estimate by an earnings multiple and getting a price target, the model says the shares' value based upon the discounted present value of the company's future earnings, adjusted for dividends, is around $60 today. I prefer the fair value method, as it doesn't rely on projecting prices out into the future to ascertain relative value; it simply says if shares are cheap right now or not.

Target has had some major issues in recent months, including the ones I mentioned in the opening of this article. This has led to volatile price performance of shares, and choppiness and downright negativity in its operating results. To that end, Target recently issued a guidance cut for its upcoming second-quarter earnings report. The cut was pretty deep, calling for Q2 EPS of 78 cents, versus a prior guidance of 85 cents to $1 and consensus of 91 cents. In other words, this was pretty bad, and shares sold off hard as a result. This reaction, of course, was warranted, as the company is apparently going to badly miss expectations for the second quarter; we'll know more on Wednesday as the company reports.

Target has some problems, of course, and some feel it is more than simply the data breach, calling out the company's strategy amid falling traffic and margins. These are valid concerns, as Target has had a rough go of it, much of it due to its own failings, and shares have reflected this reality. Target is no longer the star of discount retailing it once was, so we must evaluate whether it will regain that status or not.

Target is in a brutally competitive niche; as a general retailer, it competes with a variety of chains, but mainly with Wal-Mart (NYSE:WMT). Everyone knows Wal-Mart's stores aren't as nice as Target's, but that only goes so far; if consumers just want discounts, they are perhaps more likely to go to Wal-Mart. On the flip side, Target stores are still discount big boxes that don't offer the boutique experiences consumers on the other end of the spectrum crave. Is this a big problem? It hasn't been before, but it could be in the future, and it is something to think about. Going toe-to-toe with Wal-Mart is a difficult game to win, but I think Target still has a shot.

I will say that although I see relative value in TGT shares right now, there are plenty of risks. I've mentioned several already, but there is also the matter of earnings estimates. Can Target grow earnings at ~12% a year? That is the big question that investors will need answered going forward, and if we continue to see guidance cuts like we've just seen, shares will languish for many years to come. At this point, I think sentiment has gotten bad enough that Target doesn't necessarily need to hit those growth rates as long as it gets close. And its dividend yield should serve to buoy shares on pullbacks, as it sports a very nice yield. TGT is a risky proposition right now relative to its past, but I think sentiment has bottomed and any kind of positive catalyst will send shares higher. Couple that with the nice dividend yield, and TGT shares are at a decent entry point right now for dividend and value investors.

Source: Target Poised To See Higher Prices On Improved Sentiment