Why Target Corporation Stock Deserves to Trade Above $70

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Target stock - Why Target Corporation Stock Deserves to Trade Above $70

Source: Mike Mozart via Flickr (Modified)

Retail giant Target Corporation (NYSE:TGT) has been a pretty big winner over the past year. Target stock is up 30% during that stretch as the company has started successfully fighting back against Amazon.com, Inc. (NASDAQ:AMZN) and Walmart Inc (NYSE:WMT), turned its digital business around and promised huge benefits from tax reform.

But the rally in TGT has stalled out recently. Margin concerns coupled with broad market weakness have Target stock trading more than 10% off its 2018 highs.

Is the rally in Target stock over? Or is there still more room to run higher?

I think the latter. The story supporting TGT stock is pretty good right now. Between resurgent comparable sales growth, booming e-commerce growth, a massive toy tailwind from the Toys “R” Us, Inc. bankruptcy, and a massive tax reform earnings boost, investors have a ton of reasons to buy Target stock.

Meanwhile, the valuation is reasonable, and fundamentals support upside to up and above the $70 level.

All together, I think Target stock can and will head higher from here, despite recent weakness.

Here’s a deeper look.

The Target Story Is Strong Right Now

Walmart and Target have been interlocked in this decades long competition wherein wins and losses are exchanged with equal frequency. Because the two are so comparable, neither beats the other one for good. One simply outperforms the other for a stretch. Then, the under-performer comes surging back and turns into the out-performer.

Don’t believe me? Just look at the data.

For most of 2012-13, Target comped better than Walmart. In late 2013 and early 2014, Walmart comped better than Target. For most of 2014 and all of 2015, Target comped better than Walmart. And in 2016-17, Walmart comped better than Target.

Now, Target is making its comeback.

For the first time in essentially two years, Target reported a better quarterly comp (+3.6%) than Walmart (+2.7%). Also for the first time in multiple quarters, Target’s digital sales growth (+29%) outpaced Walmart’s digital sales growth (+23%). And Target’s traffic growth (+3.2%) was essentially double Walmart’s traffic growth (+1.6%), while Target comped positive across all five of its core merchandise groups.

This isn’t just a quarter anomaly. These shifts between Target beating Walmart and Walmart beating Target happen in multi-quarter cycles. Thus, this looks like the beginning of a multi-quarter stretch wherein Target consistently outperforms Walmart.

That is a pretty good narrative that investors will want to buy into.

Moreover, Target is set to benefit from a huge influx of toy sales thanks to the recent bankruptcy of Toys “R” Us. Target is also partnering with Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) on the company’s new Shopping Actions initiative, which essentially allows consumers to buy straight from Google (and not on Amazon). As a partner, Target could see a surge in its digital business thanks to Shopping Actions.

All together, the narrative supporting TGT stock is pretty strong right now. That strong narrative should attract buyers, and keep investor demand high.

Fundamentals Supports Further Upside

Moreover, the fundamentals support further upside in Target stock.

Over the past several years, sales at Target have been essentially flat. That should change going forward considering the company’s surging digital retail business, growing grocery business, and tailwinds from Shopping Actions and the Toys “R” Us bankruptcy. All in all, it isn’t unlikely that revenues grow around 1-2% per year over the next five years. At the midpoint, that implies revenues of $77.4 billion in five years.

EBIT margins are falling right now (they have fallen to historic lows of around 6%), and this erosion is expected to persist thanks to wage pressures. But those wage pressures should move into the rear-view mirror over the next several years, at which point higher sales should drive expense leveraging. Moreover, the mainstream emergence and adoption of automated technologies (think self check-out) should further reduce wage pressures over the next several years and help expand margins.

Over the next five years, then, EBIT margins should be able to expand slightly. My best guess here is 6.5%, versus 6% today, implying a meager 10 basis points of expansion per year.

A 6.5% EBIT margin on $77.4 billion in revenues implies EBIT of $5.03 billion. Taking out $600 million for interest expense and 21% for taxes, you arrive at $3.5 billion in net profits. On presumably 500 million diluted shares at that point in time, you’re looking at $7 in earnings-per-share in five years.

A historically average 17-times multiple on those $7 earnings implies a five-year forward price target of $119. Discounting back by 10%-per-year, that equates to a present value of around $74 for Target stock.

Bottom Line on TGT Stock

The story is good and the valuation is reasonable. I think Target stock has a clear runway to the mid-$70’s.

As of this writing, Luke Lango was long TGT and GOOG. 


Article printed from InvestorPlace Media, https://investorplace.com/2018/04/target-corporation-stock-deserves-trade-70/.

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