Target Corporation (NYSE: TGT) is a well-known company to the average U.S. consumer. With physical stores across the country and a growing online presence, the company represents a stable investment for many analysts. In today’s environment, however, the firm is facing major challenges, especially in the near and medium term. I am neutral on TGT stock.
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Retail is Becoming Increasingly Digital
In the world of online retail, many analysts and investors view physical store companies as having an inherent disadvantage in terms of operating costs and growth velocity. Others view physical stores as an opportunity to address a different customer (often of an older demographic) that is unlikely to shop online. Still, most large retailers in the U.S. maintain thousands of stores across the country while also trying to increase online sales.
Downward Price Pressures Persist
While during the first four months of 2022, Target seemed able to resist the broader market sell-off, disappointing Q2 results in May resulted in a sizable pullback. The stock hasn’t seen any signs of recovery since, as selling pressures mount.
Currently, TGT’s price is more than 30% lower compared to the beginning of the year. The stock trades at a massive ~43% discount compared to 52-week high levels and now pays a ~2.75% dividend yield.
Target’s Historical Financial Performance
Over the past five years, TGT’s revenue has grown at a 9% CAGR, while its net income CAGR is 8.77%. Profitability margins, however, have deteriorated recently, with its gross margin dropping from 30% in 2021 to 26.2% as of the company’s last filing. Net margins have followed a similar trajectory, decreasing from 6.5% to 3.9%.
Inflationary pressures and supply-chain disruptions are putting downward pressure on the company’s profitability capacity. It seems imperative that Target has to grow online sales (which offer higher margins) in order to achieve better operational positioning. Currently, 19% of total sales are digital in origin. That said, Target’s revenue mix is becoming increasingly more dependent on online sales (only 10% of its sales were online in 2019)
Another major risk factor lies in the cyclical nature of the business. Prolonged economic uncertainty or, even worse, a recession will likely stall revenue growth and further hurt profitability. While some product categories that the company offers, such as Food and Household Essentials, enjoy inelastic demand, others, like Apparel, furnishing, and Electronics, are much more sensitive to changes in consumer spending.
A Strategic Decision on Inventory Management
This year, Target’s management also embarked on a mission to optimize the company’s inventory, leading them to reduce ownership and commitments in product categories where demand has been softening. This attempt emphasized the importance of improving operating margins.
While financially hurtful in the near term, this strategic move should help the company unlock more operational efficiency, going forward. It also allowed the company to reinforce its inventory in categories like Food, Beverage, Beauty, and Essentials, which have driven sales growth through strong demand.
Growing Competitive Pressures in Retail
In today’s economy, general retail faces intensifying competition in both online and in-store sales, putting downward pressure on prices. That said, Amazon (NASDAQ: AMZN) remains the undisputed market leader in online retail, now enjoying a market share of almost 38%. Target falls behind Walmart (NYSE: WMT) and eBay (NASDAQ: EBAY) as well. The list of other large retailers also includes companies like Costco (NASDAQ: COST), Kroger (NYSE: KR), Best Buy (NYSE: BBY), and more.
Maintaining physical stores also comes with a significant operating cost burden that results in margin pressures, a burden that competitors like Amazon or eBay have chosen to forego.
Offering Attractive Dividend-Growth Prospects
Currently, Target pays a ~2.75% dividend yield (almost two times the market average) that has been growing at an annualized growth rate of 9.3% over the past five years. Cash flow from operations has grown at a similar rate over the same period, although growth has been slowing down since 2021.
As management mentioned during the recent Q2 earnings call, building on TGT’s 50-year record of increasing dividend payments remains a top priority behind investing in the business itself. That is more reassurance than most dividend-growth investors should need, going forward.
Dividend-per-share increases are also aided by the decreases in Target’s share count. Diluted average shares outstanding have decreased from 582.5 million in 2017 to about 460 million as of the most recent quarter.
TGT: Approaching a More Reasonable Valuation
Target’s stock recorded a sizable stock price retreat in May 2022 after a significant earnings miss and hasn’t recovered since. As the company that had been trading at premium valuation multiples for a while, for many value investors, this represented a possible buying opportunity.
At this time, Target trades at a 19x FWD P/E multiple that is still quite higher than the sector median of ~13x. However, its current P/E is now in line with the company’s five-year average. On a P/S basis, Target’s valuation appears more reasonable at 0.67x compared to both the sector median (0.79x) and the company’s five-year average (also 0.79x).
Is TGT a Good Stock to Buy, According to Analysts?
Turning to Wall Street, Target has a Moderate Buy rating based on 12 Buys and eight Holds assigned over the past three months.
The average TGT stock price forecast of $191.75 represents 26.8% upside potential, with a high price forecast of $223 and a low forecast of $161.
Conclusion: Wait for a Bigger Pullback
After all things are considered, the challenges the company faces in the current macroeconomic environment raise a few red flags for near-term performance. Even though Target’s valuation has improved, ideally, investors should probably look for a bigger pullback to take advantage of TGT stock.
