Is Target Built to Last?

After a 100% rise over the last 18 months, Target (NYSE: TGT  ) has certainly rewarded investors. But does the company have a wide enough moat to keep competitors at bay for the long haul?

The stuff moats are made of
Warren Buffett coined the term "economic moat" to describe the strength of a company's competitive advantages. Many factors confer short-term competitive advantages, but in his excellent The Little Book That Builds Wealth, Morningstar's Pat Dorsey convincingly argues that only four factors create an enduring economic moat. Let's use Dorsey's criteria to see what Target's moat is made of, and just how sustainable it is.

1. Intellectual property rights
Moat-building intellectual property includes intangible assets like patents, licenses, and brands. Any company can have a brand, but truly moat-widening brands must increase a consumer's willingness to pay for a product.

Moat source: Yes
Target has carved out a profitable niche in the competitive retail landscape. The company's products are cheap, but still chic, and its aesthetically pleasing stores attract a more affluent clientele than competitors like Wal-Mart (NYSE: WMT  ) and Kohl's (NYSE: KSS  ) .

2. Customer switching costs
Products that are tightly integrated with a customer's business or lifestyle make it difficult for that customer to switch to a competitor's product.

Moat source: No
While consumers may enjoy shopping at Target, they're only a coupon away from switching to Wal-Mart's everyday values.

3. The network effect
The value of some services increases in direct proportion to the number of people using them. For example, Facebook offers a much richer experience with 500 million users than it did with a handful of undergraduate dorm-mates.

Moat source: No
Additional Target shoppers only make the store more crowded for the other shoppers.

4. Cost advantages
Finally, lower costs can create lasting competitive advantages. The benefits of operational efficiencies and smart processes inevitably erode over time. A truly sustainable cost advantage, like economies of scale or a superior geographic location, simply can't be copied.

Moat Source: Yes
With a $38 billion market cap, Target enjoys an edge over its suppliers. However, its scale advantages are dwarfed by those of Wal-Mart.

Numbers don't lie
To determine whether a company enjoys a sustainable competitive advantage, examine its return on invested capital over time. Returns consistently exceeding a company's cost of capital suggest that it possesses a nice moat. Here's how Target's ROIC stacks up next to its competitors:

Company

FY2008

FY2009

FY2010

Target

11.3%

8.5%

9%

Kohl's

15.2%

11.3%

11.4%

Sears Holdings (Nasdaq: SHLD  )

6%

2.9%

4.6%

Wal-Mart

12.9%

13%

13.7%

Source: Capital IQ, a division of Standard & Poor's.

Survey says: Narrow moat!
Target's brand may be strong, but it simply can't match Wal-Mart in terms of efficiency. However, even though Target is clearly a second banana to the big W, the company still enjoys a nice niche. Thanks to the strong and steady free cash flow it generates, Target has recently popped up in the portfolios of top investors like Wally Weitz and Ken Heebner.

Ready to buy?
Not so fast, my Foolish friends! Even if you believe that Target can widen its narrow moat and fend off the competition, that doesn't automatically make it a smart buy. While competitive advantage is critical, it's also essential for investors to have a strong understanding of a company's management, finances, and valuation -- and to always buy at a significant margin of safety.

That's the strategy our team at Motley Fool Inside Value employs. You can read all of the team's research reports, and see their best buys for new money now, with a 30-day free trial.

Rich Greifner does not own shares of any company mentioned in this article. Wal-Mart Stores is a Motley Fool Inside Value selection. The Fool owns shares of Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.

 


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  • Report this Comment On September 07, 2010, at 3:32 PM, madmilker wrote:

    With the world reading this....

    on Wal*Mart's China web page!

    "Walmart entered the Chinese market and opened its first Supercenter and Sam’s Club in Shenzhen in 1996. Currently, Walmart operates a number of store formats in China including Supercenters, Sam’s Clubs, and Neighborhood Markets. As of June 27, 2010, Walmart had 187 units in 99 cities, and created over 50,000 job opportunities across China.

    Walmart China firmly believes in local sourcing. We have established partnerships with nearly 20,000 suppliers in China. Over 95% of the merchandise in our stores in China is sourced locally. Meanwhile, Walmart is committed to local talent development and diversity, especially the cultivation and full utilization of female staff and executives. 99.9% of Walmart China associates are Chinese nationals. All our stores in China are managed by Chinese local talent. 43% of leaders at senior manager level and above are female. In 2009, the company established the “Walmart China Women’s Leadership Development Commission” for driving women’s career development."

    Which doesn't help any jobs in any country but China...

    there will be more and more shopping within the bulls-eye than under that red star in between Wal*Mart.

    Remember what Lance Winslow wrote in that article "The Flow of Trade in a Global Economy"....dang! better yet...just take the time and read this ...."Now let us look at Wal-Mart again; you buy a product there, 6% goes to the employees, 10-18% is profit to the company, 25% goes to other costs and 50% goes to re-stock or the cost of goods sold. Of the 50% about 20-25% goes to China, a guess, but you get the point. Now then, how long will it take at 433 Billion dollars at year for China to have all of our money, leaving no money flow for us to circulate? At a 17 Trillion dollar economy less than 40-years minus the 1/6 they buy from us. Some say that if we keep putting money into our economy, it would take forever, but if we do not then eventually all the money flow will go. If China buys our debt then eventually they own us, no need to worry about a war, they are buying America, due in part to our own mismanaged trade, so whose fault is that? Not necessarily China, as they are doing what's in the best interests, and we should make sure that trade is not only free, but fair too."

    Also, think for a moment about George Washington....yes the man that is on the US dollar bill.... "Washington had been reelected unanimously in 1792. His decision not to seek a third term established a tradition that is now embedded in the 22d Amendment of the Constitution."

    Take the time to read his farewell address after only eight years of serving his country and than ask yourself this....How do you think George feels being sent overseas in return for all that foreign so-call cheap items and being left in a foreign bank because the American worker doesn't make anything for the foreigners to buy. Cheap items didn't make this great union of 57...oops! 50 states the greatest place on the face of this Earth.....the American worker (union and non-union) did.

    You can't have a strong country without having a strong currency and you can't have a strong currency unless you keep it floating around within your 50 states. This is why the store with the star in the name puts 95% China made items in their stores in China....to keep their "yuan" in their country helping the nice people there. And with only 5% left for all the other 182 country's that make stuff including the United States of America....that doesn't produce very many jobs outside of China.

    Being an old person myself and knowing how it was back in the 40's, 50's and 60's in this union of 50 states....I look at George each time I pull him out of my billfold and make a promise to send him out for items made in America so after floating around helping each hand he touches just maybe one day he will shake mine again.

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