Alongside the entire retail industry, mega retailer Target (NYSE:TGT) has been one the stock market’s biggest victims during the recent rout. Since the market sell-off began in early October, the SPDR S&P Retail ETF (NYSEARCA:XRT) has shed nearly 20%, while Target stock has dropped more than 25%.
Why? Everyone is concerned about a looming recession due to the threat of higher rates and bigger tariffs. Those concerns have brought the whole retail industry lower. Specific to Target, investors are concerned about valuation, currently robust sales numbers not persisting past this year, and margin issues creeping back in during 2019 and 2020.
Broadly speaking, these concerns are legitimate. The U.S. economy is slowing. There’s no way Target replicates this year’s robust growth next year. And, margins will be pressured going forward.
But, also broadly speaking, these concerns are already more than fully priced into the stock. TGT trades at just 12X forward earnings with a near 4% yield. Although next year won’t be as good as this year from a numbers standpoint, it will still be good, and good will be enough to propel a dirt cheap Target stock higher in 2019.
Thus, so long as a recession doesn’t hit within the next 12 to 18 months, Target looks woefully undervalued here and now.
The Company Has a Lot of Momentum
At the core of 2018 rally in TGT is impressive operational momentum that has been driven by omni-channel commerce initiatives.
Over the past several quarters, Target has invested big into building out its omni-channel commerce capabilities. Namely, the company has expanded its digital footprint, implemented things like “buy online, pick up in store,” and broadened its product assortment to more heavily emphasize toys and grocery.
The net result? Target has been putting up decade best numbers.
At the start of the year, Target reported a then-decade-high comparable traffic growth rate of 3% in Q1. The very next quarter, Target more than doubled that rate to 6.4%. Last quarter, Target maintained near decade high comparable traffic growth of 5.3%.
All the while, digital sales growth has been accelerating from below 30% to nearly 50%, and comparable sales growth has been running at decade high levels of 5%-plus.
In the big picture, Target has adapted to today’s retail environment, and is finding great success in being an omni-channel, one-stop-shop retail operation. Thus, it seems like the only thing that could truly derail Target stock here and now is a recession.
Recent Trends Remain Robust
There are concerns out there that 2018’s robust growth is unrepeatable in 2019. This is true. Target likely won’t report 5%-plus comparable sales growth again in 2019 because growth will naturally normalize against much harder laps. But, recent trends confirm that 2019 should be yet another good, albeit slower, year for Target.
The market is concerned about a looming recession, but consumers aren’t feeling it. The labor market remains strong. Wages continue to rise. Jobless claims dropped steeply last week. Inflation is checked. Retail sales are up big this holiday season.
Importantly, Target’s recent operational momentum has persisted amid a continued strong U.S. consumer backdrop. According to data science firm Orbital Insight, holiday shopping traffic at Target is up 7% year-over-year, versus a 6% gain at Kohl’s (NYSE:KSS) and a 5% gain at Walmart (NYSE:WMT).
This corroborates data from foot traffic analytics firm Placer.ai, which reported an above-average 11% increase in foot traffic for Target stores during Black Friday weekend.
In the big picture, while markets are freaking out about slowing growth, the U.S. consumer remains strong right now. Due to its strong operational momentum, Target is winning against this healthy consumer backdrop. So long as this consumer health persists, Target should report good numbers.
The Valuation Is Anemic
The bull thesis on Target comes down to valuation.
This stock is trading at just 12X forward earnings with a near 4% yield. Over the past five years, those figures have hovered around 15 and 3%, respectively. Thus, it is reasonable to say that Target stock is trading with a great deal of pessimism, and that slowing growth is already priced in.
My best guess for Target and the consumer in 2019 is slowing but still healthy growth. For Target, that means slowing from decade best numbers to average numbers. Naturally, average numbers deserve an average valuation.
But, Target is currently trading at a well below average valuation. This discrepancy implies a favorable risk/reward profile on Target stock heading in 2019.
Bottom Line on TGT Stock
The one thing that could drag Target stock way lower over the next several quarters is a recession. Thus, if you think the U.S. economy is heading into a recession soon, then TGT is a sell.
But, anything short of a recession should result in Target stock heading from here. The most realistic outcome for 2019 is slower but still healthy growth.
If Target can report still healthy growth in 2019, then the valuation on Target stock today looks unreasonably anemic, and this stock will perform well over the next several quarters.
As of this writing, Luke Lango was long TGT.