Target Stock Is Still Not Cheap Enough

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Target stock - Target Stock Is Still Not Cheap Enough

Source: Mike Mozart via Flickr (Modified)

For the better part of the past year, I’ve been bullish on Target (NYSE:TGT). I thought Target stock was woefully undervalued in the $50’s, and recommended buying the dip in November 2017. As the numbers improved over the next several months, I stuck with Target stock as it pushed through $70 and $80.

But, once Target stock started pushing up against $90 after strong second-quarter earnings, I warned that the rally had come too far, too fast, and that the valuation was no longer supported by fundamentals.

Since then, Target stock has dropped back to the mid-$80’s on global growth and margin concerns. But, even after this most recent sell-off, I don’t think it is time to put on the bull hat just yet.

Target is doing everything right from an operational standpoint, but, there are macroeconomic risks here — rising interest rates and stock market turmoil stifling red-hot consumer confidence, tariffs creating a margin headache and inflation pushing up expense rates. Once you factor all those risks in, Target stock doesn’t look like a great value around $84. Instead, it looks fairly valued to slightly overvalued.

As such, I don’t think Target stock is cheap enough just yet. But, if current market turmoil persists, it will get cheap enough soon, so investors should be ready to buy the dip.

Target’s Operating Fundamentals Are Good, But Not Improving

TGT has been operating in a golden era for the retail category over the past several quarters. It all started with a blowout holiday shopping season in 2017 in which every retailer benefited. Ever since, consumer sentiment and confidence have picked up to decade highs alongside strong retail sales growth. Retail stocks, including Target, have consequently been in rally mode.

But, current trends indicate that while this golden era may persist into the holiday season, the fundamentals in retail won’t get any better over the next few quarters. If anything, they will actually deteriorate some.

Why? Because the headwinds which were formerly just talk are now starting to have a real impact on the U.S. economy. Rising interest rates are curtailing big-ticket purchases like homes and autos. The stock market is a mess right now, and that is a risk to consumer spending. Tariffs are causing input costs to go up. The era of quantitative easing is over, and quantitative tightening promises to dampen the currently rosy consumer outlook.

It is tough to believe that amid all these real headwinds, the consumer remains as strong and resilient as they have been over the past several months. That doesn’t mean the consumer is about to clam up and hoard money. But, it does mean that spending will likely be less robust going forward than it has been over the past few months. Indeed, we are already seeing this with below-trend retail sales growth in September.

In the big picture, we are still going to get a blowout holiday season. That will help retail stocks. But, going forward, current growth trends will likely decelerate back to a normal pace. As such, Target stock should decelerate back to a normal valuation.

Target Stock Is Still Slightly Overvalued

The problem with Target stock is that at $90, it was being priced for the fundamentals to keep improving. Instead, the reality is that comparable sales growth will cool from decade-high levels and margins will start to be pressured by tariffs and inflation. That doesn’t mean Target is heading into an era of revenue declines and profit erosion. Instead, it just means that Target’s revenue and profit growth going forward will be less robust than current rates.

I reasonably project that last quarter’s 7% revenue growth rate cools to a more historically normal 2% rate over the next five years, while margins stabilize as operating leverage is offset by tariff headwinds. Under those assumptions, I think it is reasonable to assume that Target can do about $7 in earnings per share in five years.

Historically, Target stock trades around 15X forward earnings. A 15X forward multiple on $7 in EPS implies a four-year forward price target of $105. Discounted back by 10% per year, that equates to a year-end price target of just under $80.

Thus, in the mid-$80’s, Target stock doesn’t look cheap enough just yet. If the current sell-off persists and shares are dragged down to the mid-$70’s, that would be the time to buy the dip. Until then, the value proposition on Target stock doesn’t look too compelling.

Bottom Line on TGT Stock

Target stock is a long-term winner given its sustained dominance in retail despite rising competition. But, Target stock is slightly overvalued in the near-to-medium-term, and with economic risks piling up, this slight overvaluation doesn’t look terribly attractive.

Investors, however, should be ready to buy the dip soon, because prices in the $70’s do look compelling.

As of this writing, Luke Lango did not have a position in any of the aforementioned securities, but may initiate a long position in TGT within the next 72 hours. 


Article printed from InvestorPlace Media, https://investorplace.com/2018/10/target-stock-is-still-not-cheap-enough/.

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