Alongside the rest of the retail sector, Target Corporation (NYSE:TGT) stock has been in rally mode.
Since Black Friday, TGT stock has risen about 7% versus a 2% gain for the S&P 500. That 7% gain is roughly in line with how much the SPDR S&P Retail (ETF) (NYSEARCA:XRT) has risen in that time.
What is happening under the hood? Retailers are in the midst of their best holiday season in recent memory. Research firms have been saying that Black Friday weekend was really good for almost all retailers, while multiple recent retail earnings reports corroborate this bullish sentiment. Names from Macy’s Inc (NYSE:M) to American Eagle Outfitters (NYSE:AEO) to Express, Inc. (NYSE:EXPR) have all sounded a bullish tone on early 2017 holiday sales.
All in all, there is a rising tide in retail right now that is lifting all boats. One such boat is TGT stock.
I think TGT stock, alongside other beaten-up retail names, can continue to head higher as sentiment normalizes, valuation rebounds, and corporate tax reform materializes.
TGT Stock Shouldn’t Trade At a Huge Discount to WMT
The two all-in-one, discount retailers are nearly the same. Target skews to a slightly higher income demographic, but outside of that, consumers treat them virtually the same. There are Target people, and there are Walmart people. Both groups will always exist.
That is why TGT stock and WMT stock have more or less mirrored each other for the past decade. As one goes up, the other goes up. As one goes down, the other goes down.
When this trend breaks, it’s usually a buying opportunity.
Just look back at 2014-15. TGT stock was surging while WMT was dropping. Now, the tide has turned. WMT stock is surging while TGT stock is dropping. With time, it will turn again.
The compelling thing about TGT stock here is its valuation discrepancy with WMT stock has grown to extremes that seem irrational.
TGT stock is trading at 6x trailing EBITDA. That is near a decade-low. But WMT stock is trading at nearly double that (11x EBITDA), which is a decade-high. This is as far as the valuations on WMT and TGT have diverged over the past 10 years by a wide margin.
Moreover, TGT stock sports a 4% dividend yield. That is right around a decade-high. But WMT stock sports just a 2% dividend yield, which is a five-year low. Again, this is as far as the dividend yields on these two stocks have diverged over the past 10 years.
Does this make sense? Not really. WMT is outperforming TGT right now, but that won’t last forever. The competition between WMT and TGT is like a seesaw. “Who is winning” yields a constantly changing answer.
Why TGT Stock Can Get To $70
Under the right circumstances, I think TGT stock can head to $70 over the next several months.
Earnings are expected to fall over the next several years due to higher shipping expenses and minimum wage hikes. (TGT is raising its minimum wage from $11 to $15 by 2020.) Flattish comp growth plus margin compression leads to earnings going down.
But that earnings compression should be largely over by 2019, once the digital business scales and most of the labor expense hikes are in the rear-view mirror.
At that point in time, earnings will start growing again. Due to corporate tax reform and a broad-based rebound in retail, TGT stock should get a higher-than-average multiple at that time. Just look at WMT. It’s currently trading at a 50%-plus premium to its five-year average valuation (25x earnings currently versus 16x five-year average).
TGT stock won’t get a 50% premium, but it could easily get a 20% premium. That implies a 20x multiple for TGT stock. Its five-year average is 17x. A 20x multiple on 2019 earnings estimates of $4.20 implies a two-year forward price target of $84. Discount that back by 10% per year, and you get to a fair value of just under $70.
Bottom Line on TGT Stock
The huge valuation discrepancy between TGT and WMT makes no sense. Consequently, as sentiment in retail rebounds and corporate tax reform materializes, TGT stock could be one of the bigger winners.
As of this writing, Luke Lango was long TGT, M, AEO, and EXPR.