Target: Great Ride, We Part Ways

Summary

• One of my most successful calls of the past year, I let Target go and locked in my gains.
• While turnaround-related catalysts existed in the second half of 2017, they have become a bit more rare this year.
• I am not bearish on TGT nor the company's turnaround strategy, but I believe the great majority of the share price upside has been captured.
• Members of my private investing community, Storm-Resistant Growth , can follow this idea, as well as my other top picks with access to my model portfolio. Start your free trial today >>

When I picked Target (NYSE:TGT) to be my Cheddar TV Idea of the Month, back in August 2017, the stock seemed to be very much out of favor with investors. Trading at a forward earnings ratio in the low teens, I believed the Street had unduly punished a retailer that had already begun to show the early results of its turnaround efforts, which had started barely six month prior.

Credit: The American Genius

Today, I see TGT commanding much more respect from the investing community than it did back then. Between my original bullish call and now, the stock has climbed from $55/share to produce 48% in market value gains. Most if not all my projections materialized during the period, with current year revenues expected by the Street to reach 2015 levels after a painful dip that saw the worst of it in the 2016 holiday season.

Looking at my three-year model (see below), I continue to believe that Target can top earnings expectations, particularly by 2020. However, I also recognize the risks to my more bullish projections not materializing, particularly as (1) the pressures of everyday low prices help to both offset the benefits of increased foot traffic and cap gross margin expansion, and (2) personnel expenses should continue to rise as the company's minimum wage heads towards $15/hour. On the plus side, store remodeling investments could start to phase out within the next 12-18 months (good for future dividend growth), with the non-cash drag caused by increased depreciation expenses affecting the P&L for longer.

Source: DM Martins Research

So while I maintain my model unchanged, I believe there is little upside to my above-consensus projections. My current 2020 EPS expectations of $5.94 look achievable but admittedly closer to the best case scenario, considering the potential headwinds described above. While turnaround-related catalysts existed in 2017, they have become a bit more rare this year, and I find it hard to imagine much happening in the foreseeable future that would make me even more optimistic about the Minneapolis-based company and its stock.

What to do about TGT?

Am I bearish on Target stock? No. Do I think the company's turnaround strategy will fail, and believe current consensus expectations to be at great risk? Not at all. But in the world of stock investing, returns are usually a function of both the fundamentals of the company and the price of its equity. With TGT being up 22% YTD and 43% in the past year, respectively, and shares valued at a P/E of 15.4x (vs. 12.0x this time last year), I believe all the reasons that attracted me to this name in the first place to be fully priced into the stock.

TGT PE Ratio (Forward)

data by

YCharts

Today, TGT "graduates from my portfolio" and leaves behind its early 2017 status of retail underdog. I will sell TGT on Monday and look to allocate my funds into another name within the sector that I believe might have a more compelling risk-reward profile, Dollar General (DG) being a candidate.

Although I let TGT go, I will not discontinue coverage of this name. I still believe that the stock could head towards $89/share by 2020, presenting shareholders with 7.5% annualized upside potential from current levels, dividends included.

Analyst’s Disclosure: I am/we are long TGT, DG. 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.