Is Target Ready for Another Leg-Up?

Target NYSE: TGT is up more than 56% since the beginning of 2020, as the retailer has adjusted well to the new normal. But questions about Target’s ability to thrive in a post-pandemic world sent shares down nearly 7% following last month’s earnings report. The decline was short-lived, however, and TGT is now on the verge of fresh all-time highs.

Are shares ready to roll? Or have investors already priced in all expected growth?

Q4 Results Were Excellent

Don’t let the post-earnings reaction fool you – Target’s fourth-quarter report was pretty darn good. Here are some of the highlights:

• Q4 revenue was up 21.1% yoy to $28.3 billion, beating analyst estimates of $27.41 billion.
• Q4 adjusted EPS of $2.67 a share beat expectations of $2.54.
• Comps jumped 20.5% yoy, better than the consensus of 17.1% growth.
• Digital sales were up 118% and same-day services, which include curbside pickup, grew 212%.
• Foot traffic was up 6.5% and customers’ order totals rose 13.1%.

Let’s dig a little deeper on a couple of these bullet points, starting with curbside pickup:

Many people think that curbside pickup will go away as soon as the pandemic is over. But it seems like it’s here to stay. On the Q4 earnings call, CEO Brian Cornell said that Target has gotten direct feedback from customers who want the company to continue offering the service post-pandemic. Some people don’t want deal with delivery or go into a store. Virus or no virus.

Then there’s the foot traffic metric. Many retailers have struggled with foot traffic since the onset of the pandemic. Their customers have been making fewer trips to limit exposure to COVID-19. They have, however, made up for part of the foot traffic loss with order size gains in many cases. That Target has seen an increase in both foot traffic and order totals is impressive.

So, why did Target shares see a post-earnings dip? Were the whisper numbers much higher than the published estimates?

The whisper numbers may have been on the high end, but it turns out that there were two clear culprits.

No Guidance and Higher Capital Expenditures

Target declined to provide guidance in its fourth-quarter release due to pandemic-related uncertainty. The lack of guidance is understandable; nobody knows when life will return to normal, after all. But investors don’t like uncertainty and no guidance = uncertainty.

But the main issue appeared to be higher planned capital expenditures. Target announced that it will put $4 billion into its business annually over the next few years, significantly higher than the $2.6 billion of capex in 2020 and the $3 billion in 2019.

On the Q4 earnings call, CFO Michael Fiddelke said, “We're planning for annual CAPEX in the $4 billion range in each of the next few years to support remodels, new stores, and supply chain projects that add replenishment capacity and modernize the network, including sortation centers.”

Look, you never want to see higher expenses, but this should be viewed as an investment. A necessary investment. The retail space is extremely competitive these days – there are plenty of viable alternatives if Target’s offerings aren’t good enough. Moreover, Target has excellent management, so it is likely they will put the funds to good use and extract a nice return on investment (ROI).

The Price is Right

It seems like every company with halfway-decent growth prospects is trading at 40x forward earnings. Sometimes much more than that. But Target is trading at just a shade over 23x forward earnings. Target’s recent growth is a bit of an anomaly – this isn’t a company that is going to grow sales at a 15-20% CAGR over the next five years – but moderate growth appears realistic. High-single-digit or low-double-digit growth would be all it takes to make shares look like a bargain in the next couple of years.

Target pays a dividend of 1.35%, which is low, but not too shabby in our current low-yield environment. With a payout ratio of just 30.75%, Target has room to raise its dividend down the road. But for the time being, it’s best if Target invests heavily into its operations. There will be plenty of time for big dividend payouts when the company’s growth prospects are (mostly) exhausted.

How Should You Play Target?

Target’s fundamentals are giving investors the green light, but on top of that, the price action has been bullish of late. Target shares have been increasing on high volume and dipping on low volume, indicating favorable supply and demand dynamics. Last week, shares consolidated in a tight range – right around all-time highs.

 

If Target breaks above $203 on high volume, it will be an outstanding buying opportunity. Keep a close eye on this one.