Discount retailer Target (NYSE:TGT) ended 2023 on a strong note rising 40% from its 52-week lows. That’s continuing into the new year despite a big drop on the first day of trading that set back TGT stock.
Although a better-than-expected Q3 earnings report helped lift shares ahead of Christmas, the retail environment remains weak.
Holiday sales were below expectations and the economy remains precariously balanced. Inflation is nearing the Federal Reserve’s 2% target level, but only if you exclude food and fuel.
The price of those items remains very high. Coupled with high-interest rates, resumption of student loan payments, high credit card debt, and lower savings rates, the consumer needs to make tradeoffs.
Those will happen when she goes shopping. Although Target’s Q3 revenue was higher year over year, comparable store sales were lower. It recorded higher profits, suggesting consumers are spending more for products on fewer trips.
Target is a solid dividend stock with over 50 years of consecutive increases, making it a Dividend King. But investors need more than just a long track record to buy income stocks these days after Walgreens (NASDAQ:WBA) dividend debacle. So let’s see if TGT stock is a buy for income and growth.
A Closer Look at TGT Stock
Retail sales inched 0.44% higher in December, according to National Retail Federation data. It also doesn’t see last year’s sector growth as “sustainable” in 2024. A lot hinges on what the Fed does with interest rates.
That sort of macroeconomic look is mirrored in Target’s performance. Comps fell almost 5% in the third quarter including a 6% drop in digital sales. Only beauty product sales keep the retailer going.
Where revenue dropped in every other category, beauty products rose 2%. Most discretionary purchases are being weighed against essential spending.
Target can thank the so-called “lipstick effect,” which says cash-strapped consumers turn to affordable luxury products like lipstick and makeup during an economic downturn. They can’t afford to buy upscale goods so they purchase smaller indulgences instead.
Target isn’t alone. Macy’s (NYSE:M) also reported growth in beauty products, especially at its Bluemercury stores. The chain notched their 11th consecutive quarter of comps growth.
Economic Headwinds Blowing In
One of Target’s biggest problems is shrink, otherwise known as theft. The retailer says shrink is running rampant throughout the industry and could impact performance. Target recognized impairment charges in good part related to shrink of $64 million in Q3, a whopping 12 times greater than last year.
With the tough sales environment and rising amount of theft, Target is experiencing declining free cash flow. Year to date it’s using $1.5 billion worth of such cash, though that typically perks up in the fourth quarter. Still, trailing FCF is currently at $3.8 billion, down from $5 billion in 2022 and $7.9 billion two years ago.
Because companies uses FCF to pay dividends, it might explain why Target’s dividend payments only rose 1.9% this year. That’s worrisome as dividends are growing at a rate less than inflation. It means shareholders enjoy less income than previously received.
Still, Target’s cash flow payout ratio under 30% suggests the dividend is safe. It still has room for better growth if the economy improves. Investors needn’t worry this Dividend King will be following Walgreens’ path anytime soon.
But Is It a buy?
Target stock trades at 15 times earnings estimates, a fraction of its sales and projected earnings growth rate, and at 18x FCF. That compares favorably to Walmart (NYSE:WMT), but Macy’s and Kohl’s (NYSE:KSS) seem better valued. However, those two retailers have worse debt-to-equity ratios than Target.
As a result, Target seems a solid stock to buy. Investors should keep an eye on how the economy affects the retailer, but even after bouncing 40% higher over the past four months, TGT stock looks good to run higher and deliver more income.
On the date of publication, Rich Duprey held a LONG position in WBA stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
