Target Stock Looks Like a Short-Term and Long-Term Winner

It wasn’t that long ago that Target (NYSE:TGT) seemed like it was in trouble, and TGT stock was “dead money.”

Image of the Target (TGT) logo on a storefront.

Source: jejim / Shutterstock.com

Between 2013 and 2018, with only a few exceptions TGT stock traded between $60 and $80. The lack of returns wasn’t happening because the market was ignoring Target, one of the country’s biggest retailers. It was a direct effect of relatively weak results.

From FY2012 to FY2017 (Target fiscal years end early the following February), Target’s total revenue didn’t move. Some modest external impacts, such as the sale of pharmacy clinics as well as accounting changes, did depress revenue. But comparable sales were incredibly weak, including declines in FY2013 and FY2016.

Same-store sales are the lifeblood of a retailer — and particularly a mature retailer like Target. The company’s weak performance suggested it wasn’t keeping up with the changing retail landscape, in which e-commerce took ever-higher market share.

Target started playing catch-up a few years back. It spent heavily to build out its own “omnichannel” business. And it has succeeded.

Same-store sales have accelerated. Profit margins are expanding. And TGT stock has roughly tripled to over $200 per share.

What’s really exciting is that the rally isn’t over yet.

Understanding the Retail Model

The same reason Target struggled for years last decade is the same reason it’s doing so well this decade.

The retail model is not easy. It includes an enormous amount of fixed costs, rent and labor chief among them. It’s also not enormously profitable as a percentage of overall sales.

So same-store sales, in particular, have an enormous impact on overall profitability. Target is an instructive example.

Target’s operating profit in FY2020 was just over 7% of total sales. And that’s actually a pretty good figure by the standards of big-box retail. Its gross margins were 28.4%.

Let’s take that model and cut revenue ($92.4 billion last year) by 10%. All the fixed costs are held the same. That $92.4 billion in lost revenue reduces gross profit by $2.6 billion (as Target turns about 28.4 cents of each dollar into gross profit).

That figure is more than 40% of the company’s total pre-tax profit last year, excluding a non-cash charge related to debt retirement.

The math works the other way too, of course. Increase revenue by 10% and pre-tax profit gains more than 40%.

This math is too simplistic, admittedly. But the broad point holds. The retail model has what is known as “operating leverage.” Movements in revenue are amplified by the time they get to the bottom line.

This is why, for instance, we’ve seen so many brick-and-mortar retail bankruptcies of late, even before the novel coronavirus pandemic. Sales didn’t suddenly plunge 75% for some of those companies. But they didn’t have to. Lose incremental traffic and incremental sales, and profits turn into losses relatively quickly.

The Stimulus Boost for Target

Of course, when you add that incremental traffic, profitability jumps in a hurry.

Here, too, Target is instructive. FY2020 revenue increased just shy of 20%, thanks in part to strong online sales driven by the pandemic. Adjusted earnings per share rose 47%, even with the company facing significant costs to deal with the pandemic and with the huge jump in e-commerce demand.

Obviously, growth is going to slow in FY2021. 2020 was an unusual year for every retailer — indeed for every company.

But there’s a short-term boost arriving: government stimulus checks. Those checks should support retail demand. And they should drive better-than-expected results for Target in the first half of FY2021.

Target’s performance this year, particularly by the time we get to the second quarter, is going to look potentially weak given how huge the year-prior growth was. But the stimulus can offset some of that pressure, and potentially lead to earnings beats that can be a catalyst for TGT stock.

The Long-Term Case for TGT Stock

While the stimulus is good news, it’s admittedly not a long-term reason to invest in TGT stock. It’s more of a trading thesis.

And we’re focused here on the long-term case. It’s strong as well.

The performance of the last couple of years highlights two key factors to remember.

First, as we noted, Target’s model shows impressive operating leverage. It was true last year and the year before, when same-store sales finally accelerated. 4% or 5% same-store sales might not sound like much, but they can drive double-digit growth in earnings per share — and that’s what really matters.

Second, the Target turnaround obviously has taken hold. The company has returned to leadership in U.S. retail. And explosive growth online means broader e-commerce is a benefit to its top line, instead of the threat it appeared to be just a couple of years ago.

To some extent, the market has figured out these two important pillars of the bull case. Again, TGT has roughly tripled. That’s in part because investors are applying a higher earnings multiple to TGT stock.

But a 21x forward earnings multiple hardly makes the stock expensive. It’s a multiple that doesn’t price in consistent, steady, double-digit increases in earnings.

That’s what Target has proven it’s capable of. As long as execution continues, there’s long-term upside in Target stock.

On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.

Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. Click here to see what Matt has up his sleeve now.


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