This article is the final installment in a 5 part series discussing stocks to purchase for retirement.
I believe the five stocks I will discuss in this series of articles are excellent for retirement given the following:
- Strong, appropriate yields that allow for comfortable living
- Excellent companies with superior economics and management
- Dividend growth that is in-line or outpacing real inflation (which I characterize as roughly 4%)
- Essentially no "blowout" risk (derivative, political, etc. types of exposure)
While some of these stocks may have yields that are a bit too low to have a large weighting in a retiree's portfolio, buying them a few years before you actually need the income will give you the double benefit of strong unrealized capital gains and a much improved yield on cost.
Target is the second largest discount retailer in the US with over $70 billion in annual sales.
As a potential retirement stock, we're looking for strong economic fundamentals, which I categorize as consistent free cash flow generation and a large reliance on intangibles (i.e. brand names) rather than capital.
The retail business hasn't been particularly kind to owners of companies like JC Penny (JCP). Fashion styles are exceptionally dynamic, inventory is difficult to manage, and products are oftentimes commoditized, especially in the discount niche.
Target and Wal-Mart (WMT) on the other hand have largely been able to carve out an even deeper niche in the discount clothing market, branding their products as lowest-available cost rather than bombarding their customers with sales like JC Penny has tried.
Take a look at Target's clothing prices: $10 t-shirts, $18 polos, $20 dress shirts etc. If you're looking for discount, solid quality everyday clothing, you'll find what you're looking for at Target. Brand names include Converse, Mossimo, and Levi's.
While the apparel/accessory segment is definitely not my favorite (commoditized brands, difficult inventory management etc.), the business accounts for only 19% of TGT's total sales and seems to compliment the rest of the company's offerings.
44% of TGT's sales are derived from products that I consider to be very stable and economically resilient. These include household essentials (soap, shampoo, detergent etc.) and food. While groceries are a very low-margin business, the segment once again provides a low-cost alternative to premium grocers and generates more effective cross-selling. The consistency of these sales, which make up nearly half of company-wide revenues, allows us to add a bit of a valuation premium to the share price (higher consistency and predictability results in lower discount rate).
The other half of revenues come from the aforementioned apparel line, hardline products (TVs, appliances, entertainment) and home furniture and décor. These offerings are particularly appealing to college students and other young adults; high-definition 50' TVs for under $500 and low-cost, reliable furniture make shopping on a budget much easier, and this type of consumer can complete their lists with Target's consumer staples products.
Target's new mini Apple stores, which are present in over 20 Target locations, are another sales catalyst and initial reaction seems to be very positive.
Target says that its brand-logo is recognized by 96% of consumers, nudging out Apple and Nike. The largest barrier to entry is buried within that alone - it takes decades and a ton of resources to build up a name like Target or Wal-Mart. Secondly, real estate is a huge startup cost, and Target has a massive competitive advantage there.
Real Estate Assets
Target fully owns the land and buildings for 1,512 of its 1,763 properties. These assets are worth about $33 billion, up 14% from the previous calculation.
Given the fact that many of these properties are located on mall properties or in other high-demand areas, it is conceivable that the book value of this real estate understates the true value of the holdings. Regardless, the full ownership of the overwhelming majority of properties adds a huge cushion to an investment in Target and since these assets are largely in excellent shape, costs are much lower for TGT relative to a company that has to pay rent for its operating space.
Past Performance, Valuation and Growth Catalysts
Over the last five years, GAAP EPS has had 5.9% CAGR, rising from $3.33 to $4.28.
Over the same period, Target has rapidly been acquiring its shares at prices that appear to understate their intrinsic value. The share count, currently standing at 661 million, is down 22% from 2006. Under the current acquisition plan, $5.3 billion worth of shares can still be repurchased - about 80 million shares. By 2017, the company will likely have well under 600 million shares outstanding.
The company has a five year plan calling for $8 in EPS and $100 billion in sales by 2017. By my own calculations, assuming a 4% annual sales growth rate and similar margins, sales closer to $85 million and about $7 in EPS (based on 600 million shares) seems more realistic, but the company could see a big growth catalyst in its new Canadian segment.
Target acquired over 100 Zeller's locations in Canada, most of which will be rebranded as Target stores by 2013/2014. As a result, a $.50 drag on EPS is expected.
The company's mid-year adjusted EPS guidance, which accounts for this temporary charge, calls for $4.70 in earnings. By 2014, the Canadian segment should be meaningfully accretive to the bottom line.
At the current adjusted EPS, which appears to be both conservative and a better representation of the company's underlying performance, Target is trading at a slight discount to the broader market multiple with a 13.4 price to earnings multiple.
Of course, retirement investors are most interested on the distribution. Currently yielding 2.30%, prospective investors will be pleased to learn that the prior 1 year increase was 44%, and the five year average is 25%. Sustainable over the long-term? Perhaps not, but initiating a position at current prices will produce a yield on cost of almost 5% by the fifth year, assuming 20% annual increases and no reinvestments.
Given TGT's temporary CAPEX spending as a result of its Canadian plans, we'll have to use EPS to calculate the payout ratio (I prefer using free cash flow, which is temporarily being distorted). The payout ratio is a very low 27%. If we back out some of the Canada-related expenses and use historical FCF figures (about $3 billion annually), the payout ratio based on FCF is a similar 32%.
Investors with a few years until retirement should be purchasing shares of Target, especially on any meaningful pullbacks. I recommend reinvesting the dividends until retirement, which will further accelerate the appreciation of yield on cost.
With half of TGT's sales derived from economically-insensitive products, and growth catalysts in sales of Apple products and its new Canadian segment, the company appears to be on-track to come close to meeting its 5-year goals.
Add in the highly-recognizable brand name and predictable cash flows, and the stock can be considered a comfortable holding in any retirement account.