Target Still Looks Like a Strong Buy at Its Record High

Target's (TGT -0.36%) stock recently rallied to an all-time high after the retailer's third-quarter numbers crushed analysts' estimates. Its revenue rose 4.7% annually to $18.67 billion, beating expectations by $220 million and accelerating from its 3.6% growth in the second quarter.

Target's operating income rose 22% to $1 billion, as its EPS from continuing operations rose 18% to $1.37. On a non-GAAP basis, its EPS jumped 25% to $1.36 and topped estimates by $0.17 per share. Those impressive growth rates explain why Target's stock nearly doubled this year -- and why it could still have room to run.

Image source: Target.

Accelerating comps growth

Target's comparable-store sales rose 4.5%, which easily beat its prior forecast for 3.4% growth and marked an acceleration from the second quarter:

Source: Target quarterly reports.

2.8 percentage points of its comps growth came from its brick-and-mortar stores, while the remaining 1.7 points came from digital channels. Its total comparable traffic rose 3.1%, with growth in both brick-and-mortar and digital channels.

During the conference call, CEO Brian Cornell attributed that growth to "favorable" back-to-school sales, a "rapid acceleration" in sales of weather-sensitive categories as temperatures dropped, and "broad market share gains" across all its core merchandise categories.

Its apparel comps rose more than 10%, thanks to strong demand for jewelry, accessories, shoes, intimates, sleepwear, and women's apparel. Beauty, cosmetics, and over-the-counter products all posted high-single-digit comps growth. Household essentials and paper products comps also grew by the mid-single digits.

Its home category, which faced a tough comparison to a year ago, still posted low single-digit comps growth as customers bought more kitchen and home storage products. In its hardline categories, strong sales of mobile devices and toys were offset by declines in consumer electronics and entertainment products.

Its food and beverage unit posted low single-digit comps growth as shoppers bought more adult beverages and non-alcoholic beverages in its bakery and deli areas. Its new private label brand, Good & Gather, also got off to a strong start, and it plans to expand the brand from 650 products to 2,000 by the end of next year.

Image source: Target.

In short, Target is firing on all cylinders, and its strength contradicts the recent results of rivals like Kohl's (KSS 2.83%), which predictably blamed both the weather and sluggish sales of women's apparel for its nearly flat comps growth in the third quarter.

Looking ahead, Target expects its partnership with Disney (DIS 1.54%) -- which will expand from 25 to 40 store-in-stores next year -- to strengthen both its softline and hardline categories. It expects its comps to grow 3%-4% in the fourth quarter and about 4% for the full year.

Robust digital growth and expanding margins

Target's total digital comps rose 31%, accounting for 7.5% of its revenue, and continued its year-long streak of robust digital growth:

Source: Target quarterly reports.

Target notes that 80% of its digital comps growth came from its same-day fulfillment (Order Pick Up, Drive Up, and Shipt) services. During the call, Cornell noted that since "these same-day options rely on our store assets, team and inventory, they are much more profitable than traditional e-commerce fulfillment." It also continues to open new small-format stores, which require less capital and stock less inventory.

As a result, Target's gross margin expanded 110 basis points annually to 29.8%, while its operating margin rose 80 basis points to 5.4%. By comparison, Kohl's gross and operating margins both withered year-over-year in the third quarter.

Target expects its new loyalty program, Target Circle, to lock more shoppers into its ecosystem. Cornell claims that it's already "America's fastest-growing loyalty program" with over 35 million members and that its expansion will boost its fourth-quarter sales.

A rosy outlook and a reasonable valuation

Target expects its fourth-quarter non-GAAP EPS to grow 7% annually (at the midpoint). It also raised the midpoint of its full-year EPS forecast from 12% to 18%. Based on that new forecast and a price of $125, Target trades at about 20 times this year's earnings.

That's a reasonable multiple for a retailer with stable comps growth and expanding margins, and its forward dividend yield of 2.4% should attract more income investors. Therefore, I believe Target still has plenty of room to run as it leaves other retailers in the dust.