On February 14th, 2012 I valued Target (NYSE:TGT) using comparables Wal-Mart (NYSE:WMT), JC Penney (NYSE:JCP), Macy's (NYSE:M) and Bed, Bath and Beyond (NASDAQ:BBBY). My intrinsic value came to $75.35, at which time Target was selling for $52.27. An attractive purchase opportunity, so attractive that @stevencopley on the ValueMyStock team picked up some shares.
As I recommend, Steven revalues his holdings at least every quarter. While revaluing Target using comparables Costco (NASDAQ:COST), Family Dollar (NYSE:FDO), Wal-Mart and Macy's, he noticed that the intrinsic value had declined by a material amount, which is currently at $63.70. Steven asked me what was going on with the seemingly stable company: why had their intrinsic value declined so much between quarters?
The answer lies in the relationship between Target's FY 2011 Cash Flow Statement and our "Buffett" Formula. ValueMyStock reduces annual net income by subtracting out annual capital expenditures, which are cash outflows not recorded (expensed) on the income statement. To get a true picture of the cash generated versus the cash spent each year, we perform the following calculation in the "Buffett" Formula:
Net Income + Depreciation - Capital Expenditures = True Cash Position from Operations
Target's capital expenditures jumped from $2,129,000,000 in 2010 to $4,368,000,000 in 2011, while their net income was virtually unchanged. Their true cash position would obviously be lower for 2011 than 2010, which reduces the intrinsic value. Until Target reported their 2011 results, we were valuing them on 2010 results.
What Does This Mean?
Once we uncovered why the valuation had changed we had to figure out what this means for Steven's holdings. A review of the 2011 Annual Report taught us that Target opened 21 new stores in 2011 compared to only 13 new stores in 2010 - almost double the number of new locations! Since new stores are a capital expense we found the reason for the almost doubling of capital expenditures.
I would not label Target a value stock based on their 2011 results, as the stock is no longer undervalued. Still, Steven should not automatically sell his holdings, based on the following conclusions:
- Target has wide appeal to a large number of consumers
- Target has expanded its presence by opening new locations
- As the nation continues to rebound following the recession we expect consumer spending to increase
- Target just has a lower intrinsic value - it is not in danger of going out of business
- The price at which Steven bought Target was low enough that it made sense for him to continue holding the stock
Let this be a lesson to new value investors - stay on top of your valuations as even large stable companies like Target can change without notice. Just because the intrinsic value has decreased does not mean rush to sell your holdings - weigh other factors before selling, but if you feel that your opportunity in the stock has disappeared, then sell and move on to the next undervalued stock.