After the divestment from the less profitable geography (Canada) and a business segment (pharmacy), Target Corporation (NYSE:TGT) has emerged as a stronger company with a sharper focus on profitability and growth. Divestment of underperforming assets freed up capital for the company to invest in its core market in the last two years, and Target's FY-2016 results are an indicator that its strategies are working well, and this is starker when the company's results compared with those of some of the other big-box retailers.
Target's EBITDA declined in the four years ended January 2015, and the current fiscal marked the beginning of a reversal. While other retailers are struggling with increased operating expenses and maintaining profitability levels, the company's EBITDA grew from $6.84 billion in FY-15 to $7.34 billion in FY-16 and the EBITDA margin rose to 9.9%, up from 9.4% last year. Wal-Mart (NYSE:WMT), Target Corporation's closest competitor, saw an 11% decline in operating income during FY-2016. Even after adjusting for $620 million one-time gain on the CVS transaction, Target's margin was higher at 9.7% for the year, a sizeable increase of 8% over FY-15.
The company's same-store sales (SSS) growth turned positive since 3Q FY-15 as the strategies it undertook to improve customer experience started to yield result. The company conducted large-scale promotional activity in FY-15, which led to margin stress in that year, but has contributed to higher consumer interest in the current fiscal. It is also doing better than peers in the digital sales channel, with over 30% growth achieved in the previous fiscal.
While growth in the digital channel was lower than the 40% guidance shared earlier by management, the convergence of delivery across channels is expected to enhance the value of the digital segment to consumers. By allowing customers to order online and personally pick up from physical stores, Target Corp. is successfully integrating its two distribution channels. The company's loyalty programs, particularly the penetration of REDcards, has increased 130 basis points to 23.2% (excluding pharmacy and clinic sales) in FY-16; higher penetration of REDcards is expected to translate into higher spend per customer, contributing to improving profitability.
The company's capital investments decreased in FY-16, as it opened fewer large-format stores and enhanced the efficiency on its digital initiatives. Its planned investments of about $2-2.5 billion in FY-17 are also to be centered on creating margin impact in the future, with outlays expected to be for technology and supply chain. Target has already started launching new products in the digital space this year; it expanded its highly popular Cartwheel app in April 2016 to include manufacturers' coupons. Through its tie-up with a third-party digital coupon provider, the company can offer more competitive prices to its customers. While the product is still in trial stage, this could potentially create higher customer loyalty, higher footfalls and a resultant growth in revenue and earnings. Simultaneously, Target is also entering into collaborations to enhance its offering in the fashion/apparel segment and is launching new products in the home furnishing and kids segments. In select stores, the company is pricing its grocery products based on freshness, allowing customers to pay less for less fresh food items. These innovations on both the product and delivery fronts are expected to translate into strength for the stock.
The stock price has rallied 33% since October 2014 as the company posted quarter after quarter of positive SSS growth. FY-16 performance seems priced into the stock already, with the price increasing 7% since the results announcement in February 2016. However, Target's focus on inventory control and supply chain management, better in-store product placements, and growth from the digital channel are expected to be accretive to its earnings in the near-to-medium term. While the increase in minimum wages, announced in April 2016, could have an impact on profitability, the company's EPS will benefit from the changing sales mix towards more profitable product categories and cost savings at the operating level. The margin improvement is also in line with its stated goal of achieving $2 billion in cost savings in the fiscal period 2015-2017.
Target has also been a steady dividend payer. With a trailing dividend yield of 2.62%, the stock has been among the leading income generators in the sector. More significantly, its dividend grew at about 18% CAGR in the five years ended January 2016, despite revenue and EBITDA remaining flattish. The company has been increasing its dividends every year since 1971, and given the upward bias expected in profitability, payouts will see a sustained increase in the future. Management guides for a 5-10% increase in dividend annually.
While there still are nebulous factors like wages and consumer sentiment that are in play, sustained comp store performance and the improvement seen in profitability indeed indicate a turn of the tide for Target. It is still a good time to enter into the stock, as the expectation for FY-17 continues to be bullish.
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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.