Target (NYSE:TGT) became so cheap, investors should take a look at the absurdity. Previous articles covered EV/EBITDA ratios for Target and P/E ratios as making strong cases for buying shares. The most recent piece dived into Target's comparable sales figures and the way Target was moving to handle more of their sales online. Since investors are so quick to dismiss Target as a dead company, despite the billions in earnings and free cash flows, it might help to look at Target's online presence by itself.
Remember that Target's comparable sales figures, from their earnings release, show that digital channel contribution was substantial.
While we know the digital channel was helping to reduce the impact of the loss from foot traffic, I don't think investors fully appreciate how huge this shift was. Further, I think investors need to understand that the online sales don't always come with great margins initially. However, that hasn't stopped investors from loving Amazon (NASDAQ:AMZN).
Let's take a look at Amazon, because this comparison is going to happen. Perhaps it shouldn't, but neither should comparisons to Sears (NASDAQ:SHLD). If investors are going to make that comparison, this is about the same degree of absurdity.
Amazon is battling Wal-Mart (NYSE:WMT) for the "King of Selling Stuff from China", or if you prefer the "Retail Vs. E-tail Smackdown". Either way, investors are starting to focus in on these two candidates and are ready to leave Target out in the cold. So how effectively is Amazon growing?
Source AMZN Earnings Presentation
That looks great, right? We know sales are usually lower in the first 3 quarters and that is exceptionally true when we start looking at online sales. All in all, we can say Amazon grew their business at a blistering 22% rate, or 24% adjusted for exchange rates. If Target wants a legitimate online presence, they should be looking to grow their sales at that rate also.
So how much did Target's online sales grow? It turns out Business Insider put together an incredible chart:
The online sales for Target were absolutely soaring during the fourth quarter. I'll save you the math; they were up just over 30%. While this was still only 6.8% of their total sales, the growth is enough to suggest that Target is entirely capable of getting consumers to buy their stuff online.
Annualized Fourth Quarter Sales to Market Capitalization
Sounds like a crazy ratio, right? However, both Amazon and Target get a huge boost to their effective sales from annualizing the fourth quarter figures. It also incorporates the rapid growth we've seen in fourth quarter figures as more of Black Friday shopping went online. Make no mistake; this method understates the Price to Sales ratio for each case because it establishes higher annualized sales.
That brings us to the following chart:
If we disregard 100% of Target's sales through physical stores, which made 93.2% of their total revenue, the valuation for Target's online business would much higher than Amazon's valuation, but not obscenely higher.
I'll be the first one to admit that any price to sales ratio over 5.0 seems unlikely without after tax margins of 20% or so. There are only a few areas where profits are regularly that strong, so ratios like that should be very rare.
What If They Had The Same Valuation
Theoretically, let us pretend for a moment that investors were willing to value Target's 4 th quarter online sales at the same multiple they provide for Amazon. If that were the case, the online portion of Target's business would be valued at $13 billion. That would leave $18 billion for everything else.
Since most of earnings still come from those in-store sales, I think the remaining retail business would be very attractive at that valuation even if it did nothing but send cash back to shareholders and sell off any buildings where the stores were no longer producing sufficient cash profits.
Target's Blunders Are Hurting Sales, Not Murdering The Company
When Business Insider profiled Sears, they interviewed a former manager of the company who described in detail how the company fell apart. He blamed it on the "Shop Your Way" program that wrecked their ability to get customers through the store and out the door with purchases in hand.
"Items scanned per minute decreased from 18 to five items per minute because the program was littered with exclusions and confusion. Several items didn't ring as advertised or generate the points as expected. This resulted in long lines and angry customers. Abandoned carts meant utilizing payroll to return those items back to stock."
Investors appear scared to be in retail on the premise that the company could suddenly fall apart and they are quick to point to any blunders from management. Yes, management caused some shoppers to avoid the store. Yes, that decision hurt sales, earnings, and almost certainly share prices. However, for all the rage about consumers not shopping at Target, it isn't even close to having employees restock items after customers storm out from waiting in line.
If Target doesn't get to be mentioned in the same sentence as Amazon, then they shouldn't be mentioned with Sears either. For everything Target has done wrong, their online growth still resembles Amazon more than the company resembles Sears. For all the expectations of lower earnings in 2017, those expectations come on plans to be more competitive, not more confusing.
Target began a significant shift to build out an online platform that could dramatically increase sales. Despite rapid growth, investors aren't recognizing the sales growth in the same manner they see Amazon's growth. While Target is unlikely to ever overtake Amazon, they are no candidate for sudden failure either. At these prices, EV/EBITDA under 6x and trailing adjusted earnings/price under 12, I see a great bargain.
Disclosure: I am/we are long TGT, WMT.
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.
Additional disclosure: Investors should not construe any comment as advice to buy or sell a security.