Target (TGT 3.31%) has paid a dividend for 188 straight quarters stretching back to the retailer's initial public offering in 1967. But the stock is only a recent addition to the high-yielders club: Target's yield just this year jumped above 3%. It's now almost 3.5%, which puts the stock near the top of the S&P 500 by that metric.
TGT Dividend Yield (TTM) data by YCharts.
Target's yield reached those heights through a mix of good and bad developments. On the plus side, the company boosted its payout by 21% this year on top of 2013's 19% raise. That hike made 2014 the 43rd consecutive year in which Target has raised its dividend, more than enough to qualify it as a dividend aristocrat. So far, so good.
However, the yield also got some help from a falling share price that's tied to some serious operational struggles. Target's stock has underperformed the market since its data breach last year and botched entry into the Canadian market: The stock is down 16% in the last 13 months.
A bigger red flag for dividend investors is Target's payout ratio, which has jumped to nearly 75% of earnings recently.
TGT Payout Ratio (TTM) data by YCharts.
That trend can't continue for long before a dividend cut or a pause in payout hikes puts an end to Target's streak of raises. So, how safe is this long-running dividend?
It's all about earnings
Target's earnings in the U.S. are down 13% so far this year while comparable-store sales growth is flat. In other words, like many retailers these days, Target has had to sacrifice some profitability to protect its market share and keep customer traffic levels steady. In the quarter that just closed, gross margin fell one percentage point to 30% of sales.
But the bigger drag on earnings, by far, has been Target's move into the Canadian market. Through the first six months of the year, that division has cleaved $400 million out of profits, or almost half of the earnings that its U.S. business generated over the same period. With earnings slipping in its main market, and with Canada sapping a huge portion of what's left, you can see why Target's payout ratio has climbed so high so quickly.
Shoring up its cash position
In response to that dip in operations, Target's management has put the brakes on share repurchases. The company has spent no cash on buying back its own shares this year. In contrast, by this point last year, Target had spent $1.5 billion on stock buybacks.
In a conference call with analysts last month, Target's Chief Financial Officer John Mulligan said the pause on share repurchases will continue until operating results improve enough to strengthen the company's credit position. "While we continue to expect to return robust amounts of cash in share repurchases over time, our business performance is not where it needs to be to sustain our [high] credit ratings," he said. Target received a minor credit downgrade earlier this year when Standard and Poor's lowered its long-term debt rating to A from A+, as the retailer's earnings coverage of its fixed costs has slipped.
Foolish bottom line
Management's forecast calls for improving profit results in both the U.S. and Canada markets over the crucial holiday shopping season. U.S. shoppers are getting less price-sensitive, according to the executive team, and the Canada stores should benefit from a refreshed product offering.
Even if operational struggles continue at the level that Target's seen this year, that likely wouldn't be enough to force a dividend cut. Management would prefer to raise cash in almost any other way over ending its almost half-century dividend run. Still, if things get much worse in either of the retailer's markets, then management won't have a choice but to consider putting the brakes on that growing payout.
