Why Target Is A Better Investment Than Wal-Mart And Other Retailers

Jun.18.12 | About: Target Corporation (TGT)

By Brian Tracz

Target (NYSE:TGT) is remodeling many of its stores and repositioning other parts of its business in order to attract a more loyal customer base. Like Wal-Mart (NYSE:WMT), Target has an enthusiastic customer base and tends to maintain a fair level of novel customer experience. Though Target is subject to a fair amount of uncertainty due to fluctuations in consumer demand and fierce competition, the company has a history of maintaining profitability.

Given its valuation and its present strategic plan, I think Target is an excellent buy for both the short- and long-term investor. The company has made excellent choices in store acquisition and positioning, maintaining over 1,700 stores at the end of 2011, with about 250 of these stores selling groceries under the Super Target heading.

Valuation

Target shares, trading at around $58, have risen about 15% in the past year and are presently trading near their 52-week high. The fundamental valuation for Target, however, is still strong. The price/book for Target is 2.5, which is below the S&P consumer discretionary index average of 2.9. Wal-Mart has a price/book multiple of 4.7, and Dollar Tree (NASDAQ:DLTR) has a multiple of 9.46. In all, this means that Target has amassed a set of tangible assets that the market is valuing, comparatively, below that of Wal-Mart and Dollar Tree. On this basis alone, Target seems to have amassed a strategic asset base and set of stores that will position it for long-term growth (mentioned below), so I think we will see a market adjustment on this account.

Target shares are also among the cheapest of the major discount retailers. The forward P/E for Target is 13.4, whereas Wal-Mart has a multiple of 13.7 and Dollar Tree has a multiple of 21.5. Compared to long-standing discount clothiers, Target's price/earnings beats out, for example, JC Penney's (NYSE:JCP) multiple of 17.5. In all, Target's valuation makes for a strong buy given the company's strong strategy.

Turning Visitors into Repeat Customers

Targets in upstate New York are being renovated to include everyday groceries in a new "expanded fresh food layout remodel." Customers in the state are very positive about the new options, with many commenting that "it's about convenience, and if I can get more here, I'll do it." Indeed, the stores in upstate New York are just a few of the 1,100 Target stores being outfitted with the new PFresh format. The strategy is simple: if customers have a longer list of reasons for visiting Target in the first place, then they are more likely to buy other things while they are there. Food is obviously a good choice-competitive pricing on this end will help Target attract a consistent customer base.

Granted, this entry into food retail will not do wonders for Target's margins. Indeed, neither will its new REDcard program. However, along with smart management of inventory, these strategies will help Target turn visitors into repeat customers. Target already has a leg up on Wal-Mart in respect to net margin, with Target 0.5 percentage point higher than the discount retail giant. Increasing sales volume through loyalty programs might be just what the doctor ordered.

Long-term Profitability

The company's expansion into Canada over the next year is also welcome news. Qualitatively, customers are impressed by Target's cleanliness and relatively simple layout-attributes which will translate well in Canada. The company owns about 86% of the stores that it operates, which is a high number among the discount retailers, and owns 95% of all stores if we include stores on leased land. This makes Target stronger financially: Best Buy (NYSE:BBY) continues to suffer from sub-par cost structure because it has to pay rents on the majority of its stores. Symbolically, owning stores indicates that management has confidence in the locale of the store and its long-term profitability.

Target has met the challenge of differentiating itself from Wal-Mart. Target has recently augmented its electronics and TV retail section, which when combined with home furnishings comprise 40% of its total business. With the rest of the business, Target has a certain "X-factor." Anecdotally, I am consistently surprised by the quality of apparel (T-shirts from Target actually fit well!), which seems to track general trends in fashion rather closely. Target has lately been able to justify price hikes on its home furnishings due to its consistent quality. Savvy and clever furniture from Target consistently has the "I could see that in my bedroom" vibe, and it lacks the "discount" feel that marks some of Wal-Mart's furniture.

As the economy recovers, Wal-Mart has not kept much of the more affluent market share that it enjoyed during the recession. I believe that Target's maneuvering is in large part responsible for this, and management has an excellent history of executing its agile business strategy.

Investing in Target

Target announced on June 13 that it will be raising its dividend 20%. Additionally, Target intends to buy back about 3.2% of total shares outstanding. This makes the company an investor-friendly company that will continue to offer a competitive investment on an earnings per share basis. The consensus projected operating EPS for Target is about $4.26 for 2013, up from $4.24 in 2012. However, I take a more optimistic view for 2013 with a $4.30 target.

Conclusion

For big-box retailers like Best Buy or the late Circuit City and Linens N Things, it is (and was) a tough market for the old-fashioned "come in, browse, and buy" model of retail. This has not changed as online competition becomes an ever greater presence-Linens N Things now exist in a new form as a website. That said, Target has a diverse inventory of goods that are intuitively arranged in their dynamically reconfigured stores. If management can continue this history of vision through its food boutique renovations and loyalty reward card program, I think Target might (with Wal-Mart) be one of the last major big-boxes standing when all is said and done. Billionaires Ken Griffin, Steven Cohen, and Thomas Steyer are among hedge funds with large Target positions (see Steve Cohen's top holdings).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.