This Dividend Aristocrat Remains Attractively Priced After Releasing 2018 Guidance
- Target recently published its financial results for the fourth quarter and full year of fiscal 2018.
- The company missed expectations by a penny on the bottom line, but exceeded revenue expectations by $240 million.
- Despite a steep run-up in price since mid-2017, Target continues to look attractive given its new 2018 financial guidance.
In our experience, some of the best opportunities in the stock market occur when a high-quality company experiences some sort of temporary trouble. This allows investors to accumulate a position in these excellent businesses without paying a premium price.
Target (NYSE:TGT) was an example of this last year. Due to fears that Amazon (AMZN) and other e-commerce businesses would permanently disrupt its business model, the company traded at absurdly low valuations multiples that - in our view - were not justified given the longevity of the company's business model.
Because Amazon-related fears about Target's future, the markets seemed to forget that Target has hiked its dividend for 45 consecutive years. This makes the company a member of the exclusive Dividend Aristocrats list - a group of elite dividend stocks with 25+ years of consecutive dividend increases. You can see the full list of Dividend Aristocrats here.
Slowly, the investment community began to remember Target's business stability. The company's valuation reverted upwards, generating excellent returns for shareholders who accumulated near the bottom.
Importantly, this was driven by solid fundamental performance from the company. Target's comparable store sales trends improved, and the company's earnings and revenues appear well-positioned to resume growing.
On March 6th, the company reported earnings for the fourth quarter and full year of fiscal 2017. This article will analyze Target's earnings release and determine whether the company is still a buy at current prices.
Financial Performance Summary
Target's fourth-quarter earnings release saw the company beat revenue expectations by $240 million but miss consensus estimates for adjusted earnings-per-share by a penny.
On the top line, Target's fourth quarter sales increased by 10.0% to $22.8 billion (from $20.7 billion last year) which reflects the impact of an additional week in this year's quarter, a 3.6% increase in comparable store sales, and the addition of sales in non-mature stores.
The company benefited from comparable digital channel sales growth of 29%, which contributed 1.8 percentage points (or 50%) of comparable store sales growth.
On the bottom line, Target reported GAAP earnings-per-share of $2.02 in the fourth quarter and $5.32 for the full year. With that said, this includes certain non-recurring financial items (such as a tailwind from tax reform) that do not meaningfully represent Target's recurring earnings power. Accordingly, we prefer looking at adjusted numbers instead.
Target generated adjusted earnings-per-share of $1.37 in the fourth quarter, which represents a modest decline of 5.6% from the $1.45 reported in last year's comparable period. For the full year, Target generated adjusted earnings-per-share of $4.71, which declined 6.0% from last year's $5.01 figure.
Here's what the company's Chairman and Chief Executive Officer, Brian Cornell, had to say about the company's performance in the quarter:
Our fourth quarter results demonstrate the power of the significant investments we've made in our team and our business throughout 2017. Our team's outstanding execution of Target's strategic initiatives during the year delivered strong fourth quarter traffic growth in our stores and digital channels, which drove healthy comparable sales in every one of our five core merchandise categories. At our Financial Community Meeting later this morning, we will outline our plans to continue investing in our team and make 2018 a year of acceleration in the areas that set Target apart- our stores, exclusive brands, and rapidly-growing suite of fulfillment options. While we have a lot left to accomplish, our progress in 2017 gives us confidence that we are making the right long-term investments to best position Target for profitable growth in a rapidly changing consumer and retail environment.
Target also released fiscal 2018 financial guidance, which included guidance for the already-underway first quarter as well as the full fiscal year.
In the first quarter, Target expects a low-single-digit increase in comparable store sales as well as GAAP and adjusted earnings-per-share in the range of $1.25 to $1.45. For the full year, Target also expects a low-single-digit increase in comparable store sales and both GAAP and adjusted earnings-per-share in the range of $5.15 to $5.45.
All said, Target's financial performance was in line with expectations. The company's newly-issued financial guidance - particularly its full-year earnings guidance - is noticeably better than many analysts were expecting, and has improved Target's valuation and expected total return profile (which we discuss in the next section of this article).
Valuation and Expected Total Returns
Target's expected total returns will come from its dividend yield, business growth, and changes to the company's current valuation multiple.
The most stable component of these total returns is the company's dividend payment. Target currently trades with a dividend yield of 3.3%. Investors who buy today will "lock in" this return. In fact, today's investors will likely have a yield on cost that grows over time thanks to Target's healthy propensity to grow its dividend each and every year.
The next component of Target's expected total returns is the company's business growth. A useful way to estimate the future growth of an established firm like Target is by considering the firm's historical growth.
With this in mind, Target's historical growth in adjusted earnings-per-share is shown below. Note that for 2018's figure, we use the midpoint ($5.30) of Target's 2018 adjusted earnings-per-share guidance of $5.15 to $5.45.
Source: Value Line
Assuming that Target hits the midpoint of its 2018 financial guidance, the company will have compounded its adjusted earnings-per-share at an annualized rate of 7.5% per year between 2001 and 2018. We believe that a similar rate of growth, say 6%-8% per year, is a reasonable forward expectation for today's shareholders.
The last component of Target's future returns will be changes to the company's current valuation. The company's current stock price combined with the $5.30 midpoint of its 2018 earnings-per-share guidance give a forward price-to-earnings ratio of 14.2.
Investors can get a good sense of how valuation changes will impact Target's future performance by comparing the stock's current valuation to its long-term historical average (shown below).
Source: Value Line
Target's current price-to-earnings ratio is 14.2 and its long-term average price-to-earnings ratio (since 2001) has been 17.1. With that said, this data sample includes several years where Target was objectively overvalued (with average earnings multiples of 20 or higher).
We believe a fair value for Target is around 16 times earnings. If the company's valuation expands to this level over the next, say, 5 years, this will add about 2 percentage points to the company's annualized returns moving forward.
This rounds out the company's total return profile, which consists of the following components:
- 3.3% dividend yield
- 6%-8% earnings-per-share growth
- 2% returns from estimated valuation expansion
Even without any valuation expansion, Target should still deliver high-single-digit returns for today's shareholders.
Target has many of the characteristics of a high-quality business:
- A long history of steadily increasing its dividend payments
- A brand that is instantly recognizable to millions of Americans
- A management team that is focused on generating value for shareholders
The company is attractively priced right now, which means that long-term dividend investors with a value orientation should consider this security closely.
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This article was written by
Analyst’s Disclosure: I am/we are long TGT. 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.
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