Target Has Significant Upside Potential

| About: Target Corporation (TGT)

Target Corporation (TGT), founded in 1902, is one of the largest retailers in North America. Minneapolis, Minnesota-based company offers household essentials, electronics, accessories, home furnishings and decor products. The company operates over 1,750 stores in 49 states. In addition, it also offers merchandise products through its website, and credit to consumers through its branded credit cards.

As of Sep 6, Target stock was trading at $49 with a 52-week range of $45.28 – $60.97. It has a market cap of $32.9 billion. Trailing twelve month P/E ratio is 11.8, and forward P/E ratio is 11.1. P/B, P/S, and P/CF ratios stand at 2.2, 0.5, and 5.9, respectively. The 3-year annualized revenue and EPS growth stand at 2.1% and 6.3%, respectively. Operating margin is 7.8%, and net profit margin is 4.3%. The company has a slightly high debt-to-equity ratio of 1.1. TGT has a yield of 2.1% for its shareholders.

Target has a 4-star rating from Morningstar. While its trailing P/E ratio is 11.8, it has a 5-year average P/E ratio of 15.4. Out of 27 analysts covering the company, 13 have buy, 4 have outperform, and 10 have hold ratings. Wall Street has diverse opinions on Target’s future. The bottom line is -10.2% growth, whereas the top-line growth estimate is 12.6% for the next year. Average five-year annualized growth forecast estimate is 12.7%.

What is the fair value of Target given the forecast estimates? In this article, the 28th in a never-ending series, I will show a step-by-step calculation of Target’s fair value using discounted earnings plus equity model.

Discounted Earnings Plus Equity Model

This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:

V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value

V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]

The earnings after the last period act as a perpetuity that creates regular earnings:

Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r

While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.

Target’s Valuation

Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.

Since we are in the middle of the year, it will be more feasible to take the average of ttm EPS of $4.21 along with the mean estimate of $4.33 for the next year.

E0 = EPS = ($4.21 + $4.33) / 2 = $4.27

Wall Street holds diversified opinions on Target’s future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 12.7%. Book value per share is $22.37.

The rest is as follows:

Fair Value Estimator

V0

E0

$4.27

V1

E0 (1+g)/(1+r)

$4.34

V2

E0((1+g)/(1+r))2

$4.40

V3

E0((1+g)/(1+r))3

$4.47

V4

E0((1+g)/(1+r))4

$4.54

V5

E0((1+g)/(1+r))5

$4.61

D

E0(1+g)5/[r(1+r)5]

$41.88

BV

Equals

$22.37

Fair Value Range

Lower Boundary

$68.50

Upper Boundary

$90.87

Potential

89.32%

I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5 year discounted-earnings-plus-book-value model, the fair-value range for Target is between $68.50 and $90.87 per share.

As of Sep 6, Target was trading at a price of $48. I like Target as a company. I see great growth potential, as well. The market has under-priced Target’s growth potential. The current price of $48 indicates the stock is undervalued. Based on my FED+ fair value estimate, Target is 41% cheaper than the lower boundary of my fair-value range. The stock has 89.32% upside potential to reach the upper boundary of its fair value range.

O – Metrix Confirmation

If the math above looks too complicated for you, try estimating the fair value using the O-Metrix as such:

O-Metrix = [(Dividend Yield + Growth Estimate) / (P/E Ratio)] * 5

  • Dividend Yield: Higher is better.
  • EPS Growth: Higher is better.
  • P/E Ratio: Lower is better.

The back-testing of this valuation technique on 40 large-caps shows that O-Metrix works very well over the long-term, such as five years. I am also continuously checking on specific sectors, and the formula works very well so far.

What is the O-Metrix Score?

  • Target has a yield of 2.1%. Therefore, the yield is 2.1.
  • Growth estimate is the same as the discounted earnings model and is equal to 12.7%.
  • Since we are at the middle of the year, taking the average of ttm (11.8) and forward (11.1) P/E ratios will smooth the results. Thus, the average P/E ratio to be used in the model is 11.45.

O-Metrix = [(12.7 + 2.1) / (11.45)] * 5 = 6.46

Depending on the benchmark chosen, the market has an O-Metrix score range between 4 and 5. Target's O-Metrix score of 6.46 is in the higher-than-average fair-value range. Back-testing of this ranking system shows that companies with higher-than-average O-Metrix scores beat the market with lower volatility. At a price of $48, the company is trading within the B-Grade, above-average-return zone.


(Click to enlarge)

Summary

Target’s average P/E ratio in the last 5 years was 15.4. Besides, it is trading with a lower P/E ratio of 11.8, and forward P/E ratio of 11.1. With a profit margin of 4.33%, Target offered 2.1% dividend yield last year. The stock has a PEG ratio of 1. Its quarterly earnings growth was 11.48%. With a market cap of $32.9 billion, I expect the growth to keep its pace.

Its price to book ratio of 2.2 is well-below the market. The stock returned 5.5% in the last quarter, but lost 16.64% since January. It recently double bottomed. From a technical perspective, direction is upward. Analysts mean target price of $58.52 also implies an upside potential in the stock. Target stock has a lot of upside potential based on 12.7% EPS growth estimate. I would prefer this stock. It pays substantial dividends and priced with a low P/E ratio. I think the current price offers a profitable entry point.

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

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