When it comes to the discussion of major retailers, Target (TGT +2.43%) sometimes becomes an afterthought. Particularly with regard to the COVID-19 pandemic, retail analysts have tended to focus on Target's principal competitors, Walmart, Costco, and Amazon.
However, like its peers, local governments deemed Target essential, and it has maintained operations while several of its competitors remained shuttered. This probably helped Target stock over the past few months as a run on consumer staples helped to drive revenue increases. Now, with the stock bouncing back from its March lows, the question for investors is whether Target stock remains a buy?
Profits fell during the pandemic
Despite remaining open and benefiting from a run on consumer staples, Target's earnings report in the prior quarter brought both bad and good news to the company.
Target stock has already recovered from the pandemic. Like most stocks, it fell dramatically in late February and early March. However, the stock price surged higher throughout April and most of May. By mid-May, Target had recovered to its February high.
The latest earnings report seems to confirm the reasons for optimism. Revenue increased by 11.3%. This includes a 10.8% surge in comparable sales and an increase of 141% in digital comparable sales. Unfortunately for the company, during the COVID-19 pandemic, the cost of sales rose by 18.5%.
This, along with higher selling, general, and administrative expenses, took the company's earnings for the quarter to $0.57 per share. That amounted to a 63.3% drop from the same quarter last year when the company earned $1.54 per share.
Target compares well to its peers
Despite this drop in earnings, Target stock may stand as the best choice among the major retail stocks. Here's why.
Admittedly, the dividend could cause some concern as the company's profit in the first quarter fell short of the quarterly dividend of $0.66 per share. Fortunately, even with reduced earnings estimates, analysts still expect the company to earn $5.28 per share this year, leaving Target well-positioned to cover the payout.
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Moreover, the dividend currently yields about 2.2%. This comes out ahead of Walmart, Costco, and Amazon (which does not offer a payout). Furthermore, Target has maintained a streak of annual dividend hikes for decades. Since walking away from Dividend Aristocrat status could bring devastation to the stock, the company will probably choose to maintain the payout increases if possible. Despite the pandemic, the dividend faces no obvious threats.
Investors should also remember that even though Target dealt with initial turmoil in launching e-commerce, it has figured out how to maximize its omnichannel advantage. The 141% increase in digital comparable sales exceeded the 74% increase reported by Walmart and Amazon's 26% rise in sales. Furthermore, bankruptcy filings by peers in the apparel sector, such as Neiman Marcus and J.C. Penney, could further help to boost sales.
Despite this faster sales growth, Target lags behind many of its peers on valuation. Target stock trades at about 27 times forward earnings. That dramatically exceeds the average multiple of about 15 over the last five years. Still, both Costco and Amazon support higher valuations. While the multiple comes in slightly ahead of Walmart's forward P/E ratio of around 25, Target still compares favorably when investors factor in Walmart's slower growth rate.
Target still has room for expansion
Furthermore, the company continues to expand its omnichannel capabilities on the brick-and-mortar front as well. With 75% of the U.S. population living within 10 miles of a Target store, the company has turned to small-format stores for expansion. This serves those looking to make quick shopping trips as well as serving as a pick-up location for online orders. Also, this move brings Target closer to the rising population of central cities, a demographic that Target underserved in the past.
Also, investors should not give up on foreign markets. Yes, Target Australia has no affiliation with the U.S.-based retailer of the same name. Moreover, investors may remember the failure of Target Canada. Still, Target's presence in all 50 states may necessitate another attempt to expand across the border. If it can find a way to succeed in other countries like its peers, the company's expansion could go on for decades.
Look to the future
Both valuation and growth potential make Target stock a buy compared to its main peers. For those who have to buy a stock in the retail sector, Target seems like a more lucrative choice than Walmart, Costco, and Amazon. It supports a comparatively low multiple, and its revenue growth rates exceed that of its most direct competitors.
Despite this, investors can find reasons to doubt Target stock. Thanks to much lower profits brought about by the COVID-19 pandemic, its forward P/E ratio dramatically exceeds historical averages.
However, the higher multiple that came with falling profits may not last. For the next fiscal year, 2022, analysts forecast earnings of $6.91 per share. When divided by the current share price, this implies a 2022 forward P/E ratio of approximately 16.9. That comes in closer to the five-year average multiple for Target stock. This and a safe, growing dividend help to make Target stock a buy.
