Dividend Aristocrats In Focus Part 12 of 54: Target Corporation

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Oct 09, 2014

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In part 12 of the 54 part Dividend Aristocrats in focus series, I will examine the competitive advantage and future growth prospects of discount retailer Target (TGT, Financial). Target is the third largest discount retailer in the U.S. by market cap, behind only Walmart (WMT, Financial) and Costco (COST, Financial). The company has a long history of profitable expansion in North America; Target has increased its dividend payments for 47 consecutive years.

Business overview

Target operates 1,795 stores in the U.S., and 130 in Canada. For the full fiscal year of 2013, Target generated its $70+ billion in U.S. revenues from a diverse mix of product categories.

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The company has experienced setbacks over the last year that have been detrimental to Target’s share price. The company lost credit card data for 70 million consumers at the end of 2013 in a data breach that has created negative publicity for the company and negatively impacted sales. The company saw sales decrease 6.6% versus the year ago period for the fourth quarter of 2013, when news broke about the data breach. In total, the breach has cost Target an estimated $146 million. In addition, the company’s planned expansion into Canada has not gone as planned, which will be discussed further in the Growth Prospects section of this article.

Target’s U.S. operations are beginning to rebound from the trust erosion that came from the data breach. The company posted 0% comparable store sales growth for the second quarter of 2014. Most businesses would not be happy with 0% sales growth, but for Target this is an improvement.

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The company’s 0% comparable store sales growth in the most recent quarter has “stopped the bleeding” of negative comparable stores sales growth in the U.S. The company saw negative comparable store sales growth in both the fourth quarter of 2013, and the first quarter of 2014. Despite the recent negativity surrounding Target, the company has built a strong business since being founded in 1902.

Competitive advantage

Target’s competitive advantage is a blend of low pricing and a clean, friendly shopping experience. In a recent study, Target was found to be about 3.8% more expensive than rival Walmart. This should be expected, as Target does not have the same scale and purchasing power as Walmart (Walmart is about 6x as large as Target based on market cap). However, Target is actually cheaper than Walmart if shoppers use the company’s RED Card credit card or debit card, which gives 5% off on all Target purchases.

Target stores have a cleaner feel than competitors like Walmart, Family Dollar and other discount retail dollar stores (with the exception of Costco). While difficult to quantify, the general branding and feel of Target stores has allowed the company to compete with its larger rivals while selling its goods for a slightly higher price. Target’s management team is focused on bringing fashionable and in-style merchandise to its stores that appeals to consumers.

Growth prospects

As mentioned previously in this article, Target’s expansion into Canada has not gone as planned. The company is currently generating a gross margin of just 18% in Canada. For the company to break even, it will have to move its gross margin several percentage points higher. I believe Canada operations will break even when gross margin hits between 22% to 24% based on the company’s U.S. margins.

Target is a company very much in transition. The company did not complete any share repurchases in the second quarter of 2014 and does not plan to do any share repurchases in the third quarter. Overall, the company’s short-term growth prospects will come from correcting course in Canada, and rising comparable store sales in the U.S. The company’s comparable store sales are trending in the right direction domestically. Target will continue to follow will likely see comparable store sales growth up to 1% for full fiscal 2014 in the U.S. From 2010 through 2012, Target averaged total sales growth of over 4% in the U.S. Over the long-term, Target should be able to generate sales growth of 4% to 5% from both its Canadian and U.S. operations. E-commerce is putting pressure on the company’s margins, which is being offset by gains in efficiency. Over the long term, I expect Target to maintain a growth rate of approximately 4% to 5% in revenue, and 5% to 6% a year in EPS from revenue growth and share repurchases (likely resuming in 2015).

Dividend analysis

Target currently has a strong dividend yield of 3.3% and a payout ratio of 72%. The company’s previously discussed short-term operational issues have driven down earnings per share, artificially inflating Target’s payout ratio. The company’s payout ratio using 1 year forward earnings is a more manageable 54.5%. Despite the company’s large recent dividend hike of over 20%, the company’s long-term dividend growth rate will be around the company’s earnings per share growth of between 5% and 6% a year. Target’s strong current dividend yield makes a compelling case for investors seeking current income.

Recession performance

Target was minimally affected by the Great Recession of 2007 to 2009. The company managed to grow revenue per share each year of the Great Recession. Earnings per share dipped slightly in 2008 from $3.33 the previous year to $2.86 but quickly recovered to $3.30 in 2009 and then $3.88 in 2010. Target’s underlying business does not lose much ground during recessions because it is a discount retailer. Consumers still must buy food products and other household goods during times of economic hardship. Target is one of the cheaper retailers to sell these items, giving it a constant stream of customers in both economic expansions and declines.

Final thoughts

Target is the third-largest publicly traded discount retailer in the U.S.. The company has grown its dividend for the past 4+ decades by leveraging its business model of providing fashionable and in-style merchandise at discount prices. The company has faced significant headwinds in the last year but appears to be correcting itself. In the long run, shareholders of Target can expect a total return of 8% to 9% a year from earnings per share growth and dividends. The company is ranked 24th out of 132 businesses with 25+ years of dividend payments without a reduction using the 8 Rules of Dividend Investing. The company appears to be a bargain now based on its forward P/E and high dividend yield. Target makes a solid investment for dividend investors looking for current income and moderate growth going forward.