Target (TGT -0.54%) is finally starting to get a little respect from Wall Street again. Shares of the omnichannel retailer jumped 10% Tuesday after the company reported strong fourth-quarter earnings and detailed investment plans to drive long-term, adjusted earnings-per-share growth in the high single digits.
What was surprising about the stock's pop this week is that in the past, the market has punished Target for stepping up investments. Last year, its shares plunged when the company said it would spend $4 billion in capital expenditures in 2021. In retrospect, that money was well spent as comparable sales increased by double digits last year and adjusted earnings per share jumped 44% even as the company faced challenges with the supply chain, cost inflation, and rising wages.
For 2022 and beyond, the company now expects to spend between $4 billion and $5 billion in capital expenditures each year -- but instead of slamming the company for that announcement, Wall Street cheered, pushing the stock up double digits. Let's take a look at four reasons why investors are back on the Target bandwagon.
Image source: Target.
1. A balanced approach
It's difficult for businesses to balance investing in growth and delivering profits. These days, many of the hottest stocks put up impressive growth numbers but don't turn a profit, and if they do, you're unlikely to get a dividend.
Target straddles this line well, and its investment plan shows how. The company is raising wages to keep attracting a talented workforce during a time of labor shortages. That not only helps the business now but builds a pipeline of leadership down the road, making its workforce a competitive advantage.
At a time when many of its retail peers are closing down stores or have stopped opening new locations entirely, Target plans to open about 30 new locations every year, since increasing its brick-and-mortar footprint helps leverage its omnichannel investments like same-day pickup services. Most of those new stores are small-format locations in places like New York's Times Square and downtown Charleston, South Carolina.
Additionally, the retailer is continuing to invest in store remodels, making its stores more attractive and shoppable; plus, it's adding sorting centers to speed up its fulfillment.
Target expects those investments to drive mid-single-digit growth in revenue and operating income. It also said it would raise its dividend by 20% to 30% this year with the goal of moving toward a 40% payout ratio. It's also planning to repurchase at least $7 billion in stock this year, which would reduce shares outstanding by about 7% or more based on its current market cap. That strategy should drive both long-term growth and reward investors now.
2. A strong track record
Wall Street may have been skeptical of Target's prior spending plans because of a number of tactical errors the company made before Brian Cornell became CEO in 2014. It botched its expansion in Canada and ending up pulling out of that country, leaving itself with a $5 billion write-down. Target even outsourced part of its e-commerce operation to Amazon for 10 years.
However, Cornell has made a number of smart moves, including pulling out of Canada, acquiring Shipt, and investing in areas like grocery, owned brands, and same-day fulfillment. Those have paid off handsomely. The business has thrived during the pandemic, growing revenue 35% over the past two years, and adjusted earnings per share have more than doubled.
Target has clearly distinguished itself from the retail pack with a multi-category approach, a "cheap chic" brand, a diversified store base, and its focus on same-day fulfillment. In other words, it's earned Wall Street's trust (much as Amazon did in its earlier years). Target is spending money where it sees opportunity.
3. A clear set of competitive advantages
Along the way, Target has also established a set of competitive advantages that help lock in its gains and pave the way for future growth. Those include its owned brands, which help drive traffic and distinguish it from other retailers. The company has also formed partnerships with designers and high-profile brands like Starbucks, Ulta Beauty, CVS, Disney, Apple, and Levi Strauss, which also serve as traffic drivers and differentiate it from other retailers.
The company's success in same-day fulfillment has probably become its greatest competitive advantage in the past two years. Target has much deeper penetration in urban areas than peers like Walmart and Costco, making it well-suited for same-day fulfillment services, which have grown by nearly five times over the past two years.
Not only has the same-day program delighted customers, but it also saves the company nearly 90% per unit compared to shipping items from a fulfillment center. That's part of the reason Target's operating margins are well ahead of those of Amazon, Walmart, and Costco.
4. A great value
Finally, Target's current price tag makes it look like one of the best value stock opportunities on the market based on its price-to-earnings ratio of just 16. That's well below the S&P 500's P/E ratio at 25. With its long-term earnings targets and dividend growth plan, Target has basically assured investors they're getting a 10% annual minimum return on their investment.
And that number could move higher if the stock's valuation multiple expands, which seems likely as it should move closer to the S&P 500 average. With that kind of bargain price, a clear growth strategy, and a proven track record, it's easy to see why Target has won over Wall Street again.
