With 2016 having just ended, Target Corporation (NYSE:TGT) investors were dealt another year of TGT stock underperforming the S&P 500 and some of its peers; it’s something that’s become a bit too familiar for Target shareholders in recent years.
Like all companies, it has got its good points and bad points; any decision to buy Target stock, or any stock for that matter, should take into consideration everything positive and negative about it, leaving the ultimate decision without doubt.
Certainly, a man being fatally stabbed on Christmas Eve in a Target store in Northern California isn’t a positive. Nor is its mishandling of the company’s policy change regarding its transgender customers’ use of its bathrooms and fitting rooms.
While these aren’t game breakers by any means, you can’t help but wonder if Target is permanently off its game.
Heading into 2017, investors are going to be looking at what kind of Christmas the discount retailer had and whether there’s any point in continuing to give TGT stock the benefit of the doubt.
Here are three pros and cons central to whether you should buy Target stock.
Target Stock Pros
Reversion to the Mean: Target stock has been beaten by the S&P 500 in four out of the last six years and by its discount store peers in three of the last six — not exactly the kind of performance investors are looking for.
However, if you believe, as I do, that stocks tend to return to their historical averages after a period of underperformance or over performance, than TGT stock is ready for a bounce.
In 2015, Target underperformed the index by 289 basis points; in 2016, that spread will jump to almost 900 basis points, a much worse result than the year before.
Looking at Target’s financials, one shouldn’t be nearly as pessimistic about its chances.
Bottom Line: While the top line faced some issues in 2016, the bottom line fared much better. In the first nine months of the year ended October 29, Target’s EBITDA increased by 1.6% year-over-year to $5.3 billion and generating an EBITDA margin of 10.9%, 90 basis points higher than in the same period a year earlier.
Especially positive was its third-quarter report which saw EBITDA profits increase by a robust 6.8% to $1.6 billion generating an EBITDA margin of 9.9%, 130 basis points higher than in the same quarter a year earlier.
Even CEO Brian Cornell was surprised.
“We are very pleased with our third quarter financial results, which reflect meaningful improvement in our traffic and sales trends and much stronger-than-expected profitability,” said Cornell. “Favorable gross margin mix and efficient execution by our team drove third quarter EPS performance well beyond our guidance.”
It might be facing some top-line comp struggles but it can still deliver the goods when it comes to profitability and if I can only have strong top-line or strong bottom-line growth, I’ll take profits over sales any day of the week.
Digital: Its online sales grew by 26% in the third quarter contributing 0.7% comparable sales growth against a 1% decline in comparable sales at its physical locations. Without the online business growing, Target’s Q3 2016 sales would have looked even more anemic than they actually were.
Looking on the bright side, its digital channel grew by 60 basis points in the first nine months of 2016 and now represents 3.5% of Target’s overall revenue.
InvestorPlace contributor Chris Fraley made a good point recently that Target shoppers are younger than the typical Wal-Mart Stores, Inc. (NYSE:WMT) shopper which suggests that when it comes to growing its online business, Target’s got a much greater upside than WMT does.
More importantly, Target customers are wealthier than WMT customers, which means they’ll be more inclined to shop online and pay for the last minute shipping costs.
Target Stock Cons
Digital: Say what? Didn’t I just say that its online business was a positive for the company? I did indeed. But, business isn’t always black or white. More often it’s gray. Target should be ashamed of itself for generating only 3.5% of its business from its digital business.
Sure, $2.6 billion sounds big until you realize that Target generates more than $73 billion a year in annual revenues. I’ve said it before and I’ll say it again. If you’re a big-time retailer, online revenue has to represent at least 10% of overall sales on annual basis.
Holiday Revenue: According to S&P Global Market Intelligence, 10 U.S. retailers were expected to generate 66% of this year’s holiday revenues. Target’s on the list, which is good news, but it’s only expected to account for 3.7% of the retail revenue generated by all of the retail constituents that make up the S&P 1500.
Meanwhile, WMT, its biggest rival other than Amazon.com, Inc. (NASDAQ:AMZN), is expected to grab 23% of the holiday revenue generated by retailers in the broader index.
That’s a good news, bad news type of situation for Target.
The good news is that it spreads Target revenue across 12 months of the year making it less vulnerable to economic downturns where customers cut back on Christmas spending.
The bad news is that Christmas, as Black Friday’s history suggests, can be the difference between a good year and a great year. On that note, WMT is much more likely to please its shareholders at this time of year.
Groceries: I’m a big fan of Phil Lempert whose weekly food reviews at Supermarketguru.com I watch them religiously. Recently, he was asked about the negatives associated with Target’s move to capture some grocery business from WMT and others.
“[Target grocery sections were placed] not in the front of the store, but off to the side, or in the back,” Lempert told Fox News. “It’s still going to have food over here, and tires over there. And for some people that’s great.”
I totally can relate to that.
Before Target pulled out of Canada, its grocery section was at the back of the store’s second floor, far removed from anything. Target failed in Canada for a lot of reasons and that was certainly one of them.
Canadians aren’t particularly fond of having to hunt for their food unless actual hunting is involved.
Lempert suggests that the grocery sections are getting better placements these days but the damage may already have been done.
Bottom Line on Target Stock
Target stock is cheaper than all of its discount peers, grocery stores, and even most department stores with the exception of Dillard’s, Inc. (NYSE:DDS) whose P/E ratio is a very-low 11.1 times earnings.
It currently yields 3.3% which is better than most of its peers. If you currently own TGT stock, I’d be inclined to own it as long as the yield remains above 3%.
With a decent balance sheet and a good nose for profits, Target won’t be the worst stock to own in 2017. In fact, I think if the markets overall don’t go in the tank, Target stock could hit $90 in the next year, a level it hasn’t seen since … ever.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
