Target's (TGT -0.70%) stock declined about 30% this year as investors fretted over the retailer's slowing growth, declining operating margins, and rising inventory levels. The broader market sell-off -- driven by inflation, rising rates, and other macro headwinds -- exacerbated that pain.
However, I believe the sell-off has created a good buying opportunity for investors who can tune out the near-term noise. Let's take a fresh look at Target's main business strategies, growth rates, dividends, and valuations to see why it's still a compelling buy in this bear market.
Image source: Target.
How Target became a retail survivor
A decade ago, Target struggled to keep up with Amazon and Walmart in the crowded retail space. But in 2014, Brian Cornell took the helm as Target's CEO and focused on renovating its stores, expanding its private-label brands, strengthening its e-commerce ecosystem, offering more delivery options, and leveraging its existing network of brick-and-mortar stores to fulfill its online orders. It also opened smaller-format stores for densely populated urban areas.
Cornell's tactics breathed fresh life into the aging retailer, and its comparable store sales growth accelerated throughout the pandemic in fiscal 2020 (which ended in Jan. 2021). During the pandemic, more shoppers flocked to Target's e-commerce site and physical stores to stock up on household products and groceries, and it continued to grow even as those lockdown-induced tailwinds waned in fiscal 2021.
|
Period |
FY 2018 |
FY 2019 |
FY 2020 |
FY 2021 |
|---|---|---|---|---|
|
Comparable Store Sales Growth |
5% |
3.4% |
19.3% |
12.7% |
|
Revenue Growth |
3.6% |
3.7% |
19.8% |
13.3% |
Data source: Target. Chart by author.
Target also continued to open new stores as other retailers shuttered their weaker locations. Between the end of fiscal 2018 and fiscal 2021, Target's total store count rose from 1,844 to 1,926 locations.
Expanding margins and rising profits
Target's gross margin also held steady above 28% over the past several years, and its operating margins consistently expanded as it fulfilled more online orders through its brick-and-mortar locations. It now fulfills over 95% of its total sales -- both offline and online -- through its stores.
|
Period |
FY 2018 |
FY 2019 |
FY 2020 |
FY 2021 |
|---|---|---|---|---|
|
Gross Margin |
28.4% |
28.9% |
28.4% |
28.3% |
|
Operating Margin |
5.5% |
6% |
7% |
8.4% |
|
Adjusted EPS Growth |
15.1% |
18.4% |
47.4% |
44% |
Data source: Target. Chart by author. EPS = earnings per share.
Target's expanding operating margins enabled it to generate high-double-digits earnings growth. Those profits ensured it could continue paying its annual dividend -- which was raised recently for the 51st consecutive year, retaining its spot as a Dividend King of the S&P 500. It currently pays a forward dividend yield of 2.6%, significantly higher than Walmart's forward yield of 1.7%.
So why did investors abandon Target this year?
Target's stable growth, consistent profits, and high dividend seem to make it a good defensive stock for a bear market. But for fiscal 2022, Target only expects its revenue to grow by the low- to mid-single digits as it fully laps the tailwinds from stimulus checks and pandemic-induced shopping. Analysts expect its revenue to rise less than 4% for the full year.
That abrupt slowdown caused Target to end up with too much inventory -- especially in bulkier products like kitchen appliances, televisions, and outdoor furniture -- by the end of first-quarter 2022. As a result, it now needs to reduce those inventories with margin-crushing markdowns.
Those markdowns, along with higher supply chain costs and wages, caused Target's operating margin to slip to 5.3% in the first quarter of 2022. It expects that pressure to reduce its full-year operating margin to about 6%, while analysts expect its full-year adjusted earnings to tumble 36%.
Target expects its operating margins to stabilize in the second half of the year as it gradually reduces its inventories, but its grim near-term outlook caused many investors to head for the exits.
Why investors shouldn't give up on Target
Target clearly miscalculated the impact of the post-stimulus slowdown, but its core business is still healthy. Its Target Circle loyalty program has already grown from 35 million members in 2019 to over 100 million members today, and it continues to expand its same-day delivery and pick-up services. Target's store-in-store partnerships with Ulta Beauty and Disney are also bringing more shoppers back to its stores, and its digital sales continue to rise.
Analysts expect Target's revenue and adjusted earnings per share to grow 4% and 42%, respectively, in 2023. We should take those estimates with a grain of salt because the current macro headwinds are unpredictable. But Target traditionally has been a resilient retailer throughout both recessions and inflationary cycles -- since it consistently attracts bargain-seeking shoppers with its low prices.
Based on those expectations, Target trades at just 17 times forward earnings. By comparison, Walmart trades at 23 times forward earnings. Target's stock won't blast off anytime soon, but I believe its low valuation, high dividend, and promising growth prospects make it a great stock to buy as myopic investors only focus on its near-term challenges.
