I was wrong on Target (NYSE:TGT). I long thought Target stock, though it looked cheap, was too expensive. The company’s efforts to build out its omnichannel capabilities, I thought, would consistently pressure earnings. Add to that retail worries more broadly and TGT stock looked like a value trap.
But Target has proved me — and other skeptics — wrong. Earnings did take a hit for a couple of years, as I detailed in January. But Target’s blowout fourth-quarter report showed the company was about to reap the fruits of its omnichannel investments.
Meanwhile, right at 15 times the midpoint of fiscal 2019 (ending January 2020) earnings-per-share (EPS) guidance, Target stock still isn’t terribly expensive. So, another year of growth (and maybe a bit of multiple expansion), could get TGT stock from the current $88 to over $100.
That said, there are some potential potholes on the way to triple-digits. And investors would do well to mind the risks here as well.
The Case for Target Stock
Target’s path to becoming a true omnichannel retailer hasn’t been quick — or easy. Target stock has tumbled twice as investors lost patience. In 2017, TGT hit a five-year low below $50. The stock tumbled again late last year, nearing $60 before rebounding quickly.
One reason has been that Target’s earnings growth stalled out. Operating income declined. Margins compressed. Adjusted EPS was $4.69 in fiscal 2015, and $4.17 in fiscal 2017. It grew sharply in fiscal 2018, to $5.50, but a lower tax rate and a lower pace of omnichannel spend both contributed.
That spend is behind the company now — and the results seem strong. Target is guiding for 7-12% EPS growth this year, with analysts aiming a bit above the midpoint. The Street sees another 6% increase in earnings per share in fiscal 2020.
Both may be conservative if recent performance holds. Comparable sales rose 5.3% in Q4 and 4.8% in Q1. That type of growth leverages day-to-day store spend — and can move EPS much higher in a hurry. It doesn’t take that much outperformance for Target to post FY2020 EPS around $7, against current expectations of $6.31. Apply a slightly higher 16-17 P/E multiple to $7 in FY2020 EPS and Target stock not only clears $100, it could threaten $120.
The Risks to TGT Stock
Of course, the flipside is true as well: it doesn’t take that much in the way of disappointment to undercut TGT stock, particularly after a sizzling 33% gain so far this year. And I’m not quite convinced Target completely is out of the woods just yet.
After all, omnichannel retailing is tough. Walmart (NYSE:WMT) is finding that out, with reported losses of some $1 billion a year from its e-commerce operations. Giving consumers exactly what they want is expensive work — and it may be more expensive than even Target realizes at the moment.
There’s also a worry that comparisons are going to get tougher. FY2019 comparable growth of 5% looks hugely impressive — but Target only grew same-store and digital sales 1.3% the year before. The company faces a much tougher hurdle over the next three quarters, and into fiscal 2020. Q1 results ease that worry a bit — a big reason why Target stock jumped on the report and kept climbing — but Target needs to keep the momentum going.
There’s also the cyclical aspect of the business. Q4 and Q1 results were strong — but retailers generally should do well in a strong economy. Cyclical stocks elsewhere are seeing pressure; if consumer purses tighten, Target could well feel the pressure.
And, in either scenario, this can get ugly in a hurry. Operating margins are thin: just 5.5% in fiscal 2018, and likely modestly higher this year. It doesn’t take much in the way of labor pressure, rising fulfillment costs, or further price reductions to move those margins down by 50 bps or so — a nearly 10% impact. Cut Target’s earnings by 10% or more and lower the earnings multiple, and suddenly TGT stock is heading back toward the $60s.
Hence, the case for Target seems to come down to execution. Can the company become a legitimate competitor to Walmart and Amazon (NASDAQ:AMZN) at the top of retail? If it does, it doesn’t only help earnings. It means investors value TGT closer to WMT and not in line with department stores like Kohl’s (NYSE:KSS) and Dillard’s (NYSE:DDS). That keeps alive the combination of earnings growth and multiple expansion that can make big gains possible.
But the rising Target stock price also makes the bet a little less compelling. At lower prices, Target stock offered big upside if the skeptics (like myself) were wrong. That upside, with TGT near all-time highs, is much thinner. Even a run to $100, including the 3%+ dividend yield, only suggests about 16% total return.
And to get that return, Target has to stay on point. At this juncture, I wouldn’t bet against it — but if I bet on it, I’d be watching awfully closely.
As of this writing, Vince Martin has no positions in any securities mentioned.