All eyes are on the consumer as the fourth quarter rolls in. Holiday decorations are being adorned and winter sales are expected to be decent according to the 2023 holiday sales report published by the National Retail Federation. Americans are expected to shell out between 3% and 4% more than year-ago levels, summing to near $960 billion, per the NRF. It is prime time for the retailers – many of which report third-quarter results next week.
I have an overweight rating on Target Corp. (TGT, Financial). I see the stock as undervalued today following a severe drawdown over the past two years. Execution issues, changing consumer preferences and even theft and shrink have been nagging problems.
Holiday sales expected to rise
Company description
According to Bank of America Global Research, Target is among the world's biggest discount retailers, operating 1,900 stores across the U.S. Along with a presence in grocery, the company sells general merchandise in its Signature Categories, Style, Baby, Kids and Wellness, as well as other hard and softline products in its physical stores and through an online channel.
Key data
The Minnesota-based $51.3 billion market cap retail company within the consumer staples sector trades at a below-market 15.2 trailing 12-month GAAP price-earnings ratio and pays a high 4% forward dividend yield. Ahead of earnings next week, shares feature a high implied volatility percentage of 44% and the options market has priced in a material 7% earnings-related stock price swing when analyzing the nearest-expiring at-the-money straddle. That is the biggest expected move since its first-quarter 2022 report, according to Option Research & Technology Services. Target has topped analysts' earnings expectations in the past three quarters, and the stock has risen post-earnings in each of those instances, so there is reason to be optimistic this time around.
Earnings review
Just recently, Bank of Ameria upgraded the domestic retailer to buy on potential foot traffic increases, but with retail theft jumping 20% in 2022, there are ongoing issues in the industry. Target's second quarter was strong, however, with operating earnings per share coming in at $2.05, beating the Wall Street consensus by 29 cents with quarterly revenue growth of 0.6% to $25.3 billion. Comparable-store sales were higher year over year, but I remain uncertain as to how the management team will turn around what have been relatively dismal top-line growth trends.
Target also issued weak 2023 guidance back in August – in the $7.75 to $8.85 range versus the consensus estimate of $8.47.
Risks
Nevertheless, Target features potential gross margin improvements if foot traffic trends reveal themselves in operating results. Key risks include rising labor costs weighing on total expenses and a consumer shift to online channels, which would likely result in market share losses to competitors. Something else to consider is an uptick in delinquencies, as reported by the New York Federal Reserve on Tuesday morning- further deterioration in the customer could hurt Target's top line.
Valuation and dividends
On valuation, analysts at Bank of America see earnings having fallen sharply by more than 55% this year, but 2024 per-share profits are expected to bounce back in a big way. The current consensus estimate calls for more than $7.50 of operating earnings per share while double-digit earnings growth is seen in both 2025 and 2026. Dividends, meanwhile, are expected to climb at a steady clip, with free cash flow also turning more sanguine over the coming quarters. With a forward non-GAAP price-earnings ratio shy of 15 and robust bottom-line growth trends, I see the valuation as attractive. If we assume $8 of normalized earnings per share and apply the stock's five-year historical average earnings multiple, then shares should trade near $149. Even if we slap a 10% margin of safety to that valuation, we are still talking about a $134 stock – about 20% undervalued today.
Target: Earnings, Valuation, Dividend, Free Cash Flow Forecasts
Looking ahead, corporate event data provided by Wall Street Horizon show a confirmed third-quarter earnings date of Nov. 15 with a conference call immediately after the numbers cross the wires. You can listen live here. Shares trade excluding the $1.10 quarterly dividend the previous Tuesday.
Corporate Event Risk Calendar
The technical take
There's a lot of red drawn on the chart below. Indeed, the Target bears have been in control since the stock peaked nearly two years ago around $269. A more than 60% drawdown has, for now, bottomed out near $103 a month ago. Notice in the graph below that shares have important resistance in the $135 to $139 area. There is another layer of resistance in the low $180s. Clearly, the bulls have their work cut out for them considering the long-term moving average is negatively sloped. Moreover, the relative strength index momentum indicator at the top of the chart is firmly in the bearish 20 to 60 range.
I would like to see the stock hold the October nadir for sure, and that price point offers investors a bit of a bogey. Long here with a stop under $100 makes for a favorable risk-reward based on recent price action developments. Another layer of longer-term support comes into play near $90. Taking profits should be taken on an approach of $135 is prudent. With high volume by price, seen on the left side of the chart, there is likely to be a hefty amount of natural selling pressure right around where I see fair value on Target.
Overall, the chart is not very constructive, but a risk-managed long play is feasible here. Still, be on the lookout for a significant stock price move on the earnings date next week.
Target: Intense Downtrend, Playing the Bounce
The bottom line
I have an overweight rating on Target. Despite a risky chart, the company is profitable with improving earnings and free cash flow trends in the coming periods. I view shares as undervalued today.
