Target (NYSE:TGT) was one of my first choices when singling out a pick for Stocks 2007. The store with the red bulls-eye logo has enjoyed great success in luring shoppers to "expect more and pay less."
While Wal-Mart (NYSE:WMT) has recently had problems with anemic sales growth, Target's still been firing on all cylinders. This performance has been reflected in both companies' share prices; as of this writing, Wal-Mart's shares have decreased approximately 4% over the past 12 months, while Target's have increased 9% over the same time frame.
Too cool for school
Target has had a great deal of success in luring not only lower-income customers, but also more affluent shoppers seeking a great deal. Although Costco (NASDAQ:COST) has had similar success in attracting consumers in higher demographics, when people began pronouncing Target "Tar-jhay," it started becoming clear that the discounter had become an expert in cheap couture. Indeed, Target stocks inexpensive, trendy clothing and accessories that even many fashionistas enjoy wearing. Wal-Mart has been recently trying to emulate that focus on fashion, with little success thus far.
Even if you're not a Wal-Mart hater, you can't deny that the company's had image problems recently. Many folks dislike Wal-Mart, and go out of their way not to shop there. Some even try to block its entry into certain communities. Although Wal-Mart has a successful track record in rural areas, it seems to be facing more friction when entering certain urban and suburban areas. Not so with Target.
Even beyond any "moral" implications of the Wal-Mart-vs.-Target debate, many people note that the interiors of Target stores tend to be more appealing than those of its biggest competitor. Some Target stores even have Starbucks (NASDAQ:SBUX) cafes inside; it certainly can't hurt Target's brand to be associated with one of the greatest aspirational brands around.
Target's growth potential also made it an appealing Stocks 2007 pick. It only has 1,500 stores; compare that to the 3,973 Wal-Mart stores (including supercenters and Sam's Clubs) in the United States, and you can see that Target still has opportunity.
Indeed, one market research firm recently made a bold prediction that Target can grow sales to $95 billion by 2010. Although Fool contributor Tim Beyers thought that was too ambitious a claim, there's little doubt that Target's got upbeat prospects.
On the other hand ...
That said, I had a few nagging doubts about Target. If anything, there may have been too much positive sentiment about the retailer recently. Over the summer, word circulated that investing guru Warren Buffett of Berkshire Hathaway (NYSE:BRK-A) had taken a stake in the retailer (although shortly thereafter, he reportedly pared it way down). Buffett's attention put Target shares squarely in the spotlight.
Although debt on the balance sheet isn't necessarily a bad thing, and many companies employ smart use of debt for growth, I prefer debt-free investments. Target's got $9.12 billion in debt compared to its $451 million in cash. That's not a daunting amount, given Target's financial performance and impressive free cash flow (it generated $1.06 billion in free cash flow last year), and its debt-to-equity ratio is about on par with its peers. Still, debt generally gives me pause.
Speaking of debt, Target's credit card operations have notably boosted its sales; at the end of the most recent quarter, its credit card receivables totalled more than $6 billion. This boon also represents a risk, though; while Target does tend to have a more affluent (and therefore more economically resilient) clientele than some of its low-priced rivals, there's always the chance that a severe economic downturn could mean more people aren't good for their obligations.
Last but not least, there's the competition. Target's fashionable, feel-good brand leaves it well-positioned to excel against its rivals, but goodness knows there are plenty of them. Even discount department stores such as J.C. Penney (NYSE:JCP), which has recently started hiring designers to provide exclusive clothing lines, are taking aim at Target. And who knows -- maybe Wal-Mart, despite the slow start of its Metro 7 line, will find the right merchandise to attract more upscale customers. I don't think it's likely these companies could steal some of Target's cool factor, but it's still possible. Discount retailers have noticed Target's magic touch, and judging by their recent efforts to step up their upscale appeal, I'd say they're mighty jealous.
Maybe next year, Target
Long story short: I do like Target. I think it's proved itself a smart, solid company, well-positioned for the long term. However, when it comes to Stocks 2007, I ended up choosing a debt-free retailer that I believe has great growth potential and sustainable competitive advantage. (It might even curry favor with some of the same hip customers Target attracts, although its merchandise can be much pricier -- and downright hard to resist, for some of us.)
Even better, the retailer I preferred has gotten hit by what I believe is temporary negative sentiment in 2006; its fundamental strengths remain the same, but its stock is now cheaper than it has been for some time. Given our goal to search for solid companies with exemplary growth prospects, it's even better when we find them on sale.
All the same, in 2007, I'll be keeping my eye on Target.
There are several promising retail stocks outlined in our annual compilation, Stocks 2007: The Investor's Guide to the Year Ahead. You'll also find interesting investment ideas in other industries.Get your copy today.
Alyce Lomax owns shares of Starbucks. Starbucks and Costco are Motley Fool Stock Advisor recommendations. Wal-Mart and Berkshire Hathaway are Motley Fool Inside Value picks. The Fool has a disclosure policy.
