Mr. Market has been rather moody lately. One day he’s positively depressed; the next he’s ecstatic. And this moodiness is obviously seen in the volatility the stock market has displayed since the year began. Although the S&P 500 is down just over -4% YTD, it’s been a rather whipsaw journey there.
It’s a good thing I don’t worry about the valuation or trends of the broader stock market, and furthermore do not compare my results directly to the S&P 500. I’m free of such burdens, instead choosing to focus on individual high quality companies, and the quantitative fundamentals as well as qualitative aspects therein. As such, I’ve been hard pressed to pass up some of the attractive prices on certain, individual stocks over the last couple weeks.
As many of you regular readers are already aware, I get one large commission check once per month as my day job is a sales-oriented position and I’m paid on a commission-only basis. Well, that check hit my bank account today (Thursday) and I went shopping!
Target is a retailer that was incorporated in 1902. They currently operate in two segments: U.S. Retail and Canadian. They own and operate 1,919 stores throughout the U.S. and Canada, as well as online retailing through Target.com.
Now, I’ve already averaged down on shares in Target once after my initial equity investment in the company at $66.50 per share back in mid-November by buying an additional stake at $62.50 per share just last month. So you can imagine how ecstatic I was when I realized I had the opportunity to increase my stake yet again for a much lower price.
Just like I love a good sale on groceries or gas, I love a good sale on stocks. Even better if it’s a stock I already own as I get the opportunity to reinvest at advantageous rates. If I already did the research and concluded a stock is worth $X, I’m more than happy to quickly review my analysis for errors and buy at less than $X if the reasoning is sound.
I’ve already discussed Target at length recently, so I’m going to try and not reiterate myself too much. Hence, I’ll be focusing on different aspects and newer developments in this article.
However, I do want to touch on one important point this time around. In the last six months shares in Target are down just over -22% over the last six months. Meanwhile, the S&P 500 is up a little over 4% over this same period. An underperformance of 26% over such a short time period is pretty interesting to me, and it’s something that gets my attention quite quickly.
Now looking at this situation further we can see that Target has ~632 million shares outstanding and the price of shares are down some $16.00 per share over the aforementioned time frame. That means that Target has lost a market cap of ~$10.1 billion over the last six months. Do you really think Target has lost the equivalent of over $10 billion worth of its business in just six months? Do you think shares in Target were overvalued by that much six months ago? Do you believe Target is going bankrupt? I believe none of these to be true, so I continue to increase my stake with what capital I have available.
Now, don’t get me wrong: Target is not without its troubles.
The data breach continues to dominate the headlines. We all know the story: Target had a massive data breach that affected 110 million customers – with personal data theft affecting 70 million and another 40 million realizing their credit card information was stolen. While this is an unfortunate incident, Target has been outstanding in communicating the loss immediately and effectively. They’ve continued to update customers through regular emails, and have even offered to provide customers with a year’s worth of a free credit monitoring service.
And I don’t doubt this will be a costly incident. They’re going to face claims in regards to fraudulent purchases using stolen information and they’ll have to change POS hardware and/or software depending on the market. But to further prevent future issues they’re going to roll out chipped REDcards six months early, to hopefully limit future data loss. However, to put this in perspective The TJX Companies’ (TJX) data breach involving 45 million customers’ credit card information back in 2007 reportedly cost the company $256 million. Even if Target spends double or triple that amount the company has been unfairly punished here.
Meanwhile, I actually see the lackluster Canadian expansion as a bigger problem for the company because this can have lasting effects on the company’s ability to expand in other international markets. However, I think many of the issues afflicting the company’s Canadian stores – prices higher than what Canadian shoppers expected, dirty stores, lack of merchandise availability – can be fixed. Target is a highly successful retailer that’s been around a long time, and I think they’ll eventually get this right.
The company’s substantial growth speaks for itself. Revenue has a compound annual growth rate of 4.78% over the last 10 years – with revenue rising from $48.1 billion in 2003 to $73.3 billion 2013. Earnings per share has a CAGR over this same time frame of 9.42%, up from $2.01 to $4.37. These growth rates are pretty impressive for a low-margin business such as retail. Furthermore, S&P Capital IQ predicts an 8% CAGR in EPS over the next three years.
The dividend growth has largely followed suit. The 10-year dividend growth rate stands at 21.4%, although I don’t expect this extremely robust rate to continue. Although, a dividend growth rate even half this rate would still make me a rather happy shareholder and allow Target to be a strong long-term investment. And with 46 years of dividend growth under its belt and a low payout ratio of just 46%, I expect dividend growth to continue for the foreseeable future. The entry yield on shares right now is 3.08%, which is near an all-time high.
The balance sheet is fair for Target, with a debt/equity ratio of 0.75 and an interest coverage ratio of 7.
The P/E ratio on TGT right now is 14.99, which is on par with its 5-year average; however, this is on lower-than-usual earnings, and I think as earnings normalize once we get past the data breach issue and Canadian operations improve the value in shares at today’s price will show itself.
I valued shares using a typical Dividend Discount Model analysis using a 10% discount rate and a 8% long-term growth rate (below TGT’s historical average) and this gives me a fair value on shares of just under $93.00. You could lower the growth rate to 7%, which is much lower than what TGT has historically delivered, and you’d get a fair value on shares of ~$60. Either way, I think a solid margin of safety exists here on TGT shares at today’s price.
This purchase adds $34.40 to my annual dividend income, based on the current quarterly dividend payout of $0.43 per share.
My portfolio now holds 44 positions. This is an increase since my last update. Although TGT was not a new investment, I did recently receive spin-off shares in ONE Gas Inc. (OGS) from my investment in Oneok, Inc. (OKE).
I’m going to include current analyst valuation opinions below, as I use these to concentrate my reasonable valuation estimate.
*Morningstar rates TGT as a 4/5 star value, with a fair value estimate of $64.00.
*S&P Capital IQ rates TGT as a 3/5 star Hold, with a fair value calculation of $63.00.
I’ll update my Freedom Fund in early March to reflect my recent addition.
Full Disclosure: Long TGT, OGS, OKE
What are you buying now? A fan of Target at today’s prices?
Thanks for reading.
Photo Credit: Stuart Miles/FreeDigitalPhotos.net
Edit: Corrected software/hardware error.