By most accounts, Target (TGT -0.36%) had a terrible 2022. Sure, revenue managed to grow 2.8%, driven by a 2.1% increase in shopper traffic. But that growth came at a steep cost.
Target's operating income plummeted 57% on the year, coming in at a meager $3.85 billion -- an operating income margin of just 3.5%. That doesn't sound like a no-brainer dividend stock at all.
Beneath the turbulent surface that is the U.S. economy, though, Target is steadily kicking its feet and staying focused on its long-term initiatives. Positive progress could be about to make a comeback in 2023. Here's why I still like this top retail dividend stock.
2022 profit margins were an anomaly
CEO Brian Cornell and the top team did a great job getting Target in position to best serve shoppers during the early years of the pandemic. The company reimagined their extensive store network as not just a place to shop, but also from which orders could be fulfilled -- whether shipped locally, or picked up by the purchaser after being ordered online.
The numbers speak to the success. Cornell said on the Q4 2022 earnings call:
Since 2019, our store base has only grown slightly, but total sales grew nearly 40% in that time frame. Our digital business nearly tripled in size, and our sales per square foot increased by 37%. And fulfilling substantially all that growth through essentially the same asset base was nothing short of incredible on the part of our team.
That kind of efficiency sounds more like a great dividend stock. But what of that plummeting operating income of $3.85 billion last year? After all, Target's dividend (currently yielding 2.6% a year, which includes a 20% hike to its quarterly payout last June) cost the big-box store $1.84 billion in cash in 2022.
Management opted to return an additional $2.83 billion to shareholders via stock repurchases. The total cash return of $4.67 billion exceeded operating profit and dipped into the balance sheet ($2.23 billion in cash and equivalents, $16.1 billion in debt at the end of the year). That's hardly a sustainable situation.
Remember that Target had to make some tough decisions with its inventory. After the first two years of heavy pandemic spending on higher-margin merchandise like home goods, inflation got hot in 2022. Shoppers began emphasizing lower-margin groceries and household basics instead. It wasn't the quick turnaround I thought it would be back in the autumn, but Cornell continues to believe action taken earlier in the year will get Target back to its 6% operating margin... err, target... before too long.
New initiatives to increase operational efficiency
Target's digital sales now stand at 19% of total revenue, according to Cornell, which is all fine and well -- except that e-commerce has taken a step back as of late, with consumers favoring in-person experiences again.
What's next for Target? Much of the same as in years past. As inflation begins to ease, Target will begin to add back sales of some higher-margin inventory. It will also continue making the most of its real estate, using its stores to fulfill the vast majority of orders -- over 95% of them -- both online and in-person.
Basically, Target will return to a slow-but-steady revenue grower (low-single-digit percentage) from here on out while it focuses on more profitable growth. Two initiatives should help.
First, there's the Target Circle rewards program, which was introduced in 2019 and has built 50 million users, whose users get rewards totaling 1% of purchases, and Target RedCard (credit and debit card) holders get 5%. The company plans to keep fleshing out this program to keep customers coming back.
And second, there's Roundel, Target's media company (read: advertising solutions for product partners). It seems like every big retailer is leaning in on ad sales these days, and for good reason. The advertising market hauls in hundreds of billions of dollars a year. Amazon has been doing it via its online marketplace to fantastic success, and Walmart is making a solid go of it too via a partnership with ad software company The Trade Desk.
Why not Target as well? Cornell said investing in Roundel will make Target more profitable, not to mention gives it better insight into consumer preferences.
Because of the nasty effects of its inventory cleanout last year and subsequent tumble in profit, Target currently trades for 26 times trailing-12-month earnings per share. However, shares trade for 19 times earnings based on forward estimates for 2023. Indeed, if this retailer can continue to grow gradually and notch a big rebound in profit margins this year, it could be a no-brainer dividend stock to buy right now and hold for the long term.
