At the height of the so-called “Retail Apocalypse” in 2017, everyone was counting out big box retailer Target (NYSE:TGT). Its closest peer and biggest rival, Walmart (NYSE:WMT), had adjusted to e-commerce disruption by building out a robust online business and expanding its omni-channel capabilities. Target, quite simply, had not done any of that.
The result? While Walmart was rattling off big comparable sales growth quarter after big comparable sales growth quarters that year, Target had a tough time just comping positive. Investors thought the writing was on the wall — Target was doomed, thanks to e-commerce disruption. As such, in July 2017, TGT stock was a $50 stock trading at a dirt cheap 10x trailing earnings multiple, and coming off the heels of a 30% sell-off over the prior 52 weeks.
How times have changed since then.
Today, the retail apocalypse has turned into a retail recovery, and TGT stock is a $110 stock trading at a highly respectable 18x trailing earnings multiple, with an impressive trailing 52-week gain of nearly 25%.
What happened? Over the past two years, Target has built out a robust online business. The Minneapolis company rapidly expanded its omni-channel capabilities. And, it dramatically refreshed its in-store presentations to be more tech-savvy.
The result? Target has consequently rattled off nine consecutive quarters of positive comps, including decade-best traffic growth numbers over the past few quarters. This big growth streak has powered a huge rally in Target stock.
All of this should continue for the foreseeable future. Except for one part — the huge rally. Put simply, TGT stock was dirt cheap two years ago. Today, it’s fully valued. So, while healthy growth should persist, multiple expansion should not. Ultimately, valuation friction will likely limit further near-term upside in Target stock.
Target will Continue Firing on all Cylinders
From where I sit, the fundamentals underlying TGT stock look really good. They broadly support the idea that positive comps, margin expansion, and healthy profit growth are here to stay for the foreseeable future.
Starting at the top, the U.S. consumer remains healthy, supported by strong labor conditions (low unemployment and strong wage growth) and favorable spending conditions (low rates and more rate cuts on the way). Indeed, the U.S. and global economic environments appear to be improving, as evidenced by upward movement in Citi’s Economic Surprise Index and a stabilizing global OECD leading indicator, respectively.
Healthy economic conditions are keeping the U.S. retail sales environment similarly robust. Over the past three months, retail sales are up 3.2%. Within that strong U.S. retail sales environment, general big-box retailers like Target and Walmart are gaining share because they are expanding their product assortments and becoming all-in-one, one-stop-shops with unparalleled convenience.
Further, within that expanding general big-box retail space, Target is the the cream of the crop. Sure, Walmart is bigger. But, Target is growing more quickly — both online and offline — and has been growing more quickly for seven straight quarters.
Net net, Target is the hottest company in the hottest space in a stable growth U.S. retail market supported by healthy labor, economic, and spending conditions. Broadly, that means Target will continue to report solid numbers for the foreseeable future.
Target Stock is Fully Valued for Big Growth
The problem with Target stock is that it will likely lose its biggest driver: multiple expansion.
Over the past two years, TGT stock has gained about 90%. During that stretch, Target’s trailing price-to-earnings multiple has risen about 60%, while trailing EPS has risen about 30%. When it comes to the 90% gain in TGT stock over the past two years, two-thirds of that gain has been driven by multiple expansion.
That multiple expansion probably won’t persist going forward. At the current moment, Target stock trades at just under 18x forward earnings. That’s above the market average forward earnings multiple of 17x. One could reasonably argue that TGT stock is actually due for some multiple compression over the next few years, edging back to a market multiple.
Big picture, Target stock is no longer in a position to drive growth through multiple expansion. Instead, all growth going forward will be from earnings improvement. How much are earnings projected to rise? About 7% next year and 10% the year after that. Assuming multiple compression back toward the market multiple, then you’re looking at potential gains in TGT stock over the next few years of about 7%-8%.
That’s fine. But, not compelling. As such, at current levels, I think valuation friction ultimately limits near to medium-term upside in TGT stock.
Bottom Line on TGT Stock
Target is a great company, and TGT stock is a great holding. But, what I loved about Target stock back in mid-2017 — an improving growth trajectory converging on a significantly discounted valuation — no longer remains true today. Instead, what you have is a stable and healthy growth trajectory, coupled with an above-normal valuation.
That’s an okay combo. But not a great one. As such, I think the best of the TGT stock rally is in the rear-view mirror.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
