My Crosshairs Are On Target
- The company published its Q1 report on May 23rd and declined 5.3% after missing analyst estimates
- Margin compression has caused fears over future performance
- Were the results really that bad, or are investors focusing too much on wall street predictions
- Target has increased dividends for 50 years in a row with a dividend yield of 3.50%
Target Corporation (NYSE: TGT) started in 1902 under the name Dayton Dry Goods Company by its founder, George Draper Dayton. Since then the company has grown to become the second largest discount retailer in the United States behind Walmart (NYSE: WMT).
The company is diversified equally among 5 business segments, Beauty & Household Essentials, Food & Beverage, Apparel & Accessories, Home Furnishings & Decor, and Hardlines.
The company is currently modernizing key aspects of its business, digital marketing and e-commerce have been a big focus since Amazon (NYSE: AMZN) started disrupting the sector with its huge growth on virtually no profit. Redesigning over 1,800 stores as showrooms and neighborhood fulfillment centers will make it easier for Target’s e-commerce by outsourcing warehousing and shipping. This will help boost the profit margins in future as they can close down brick and mortar stores that have the lowest profitability.
Within the last 12 months, Target has rolled out new technology that includes a mobile wallet, they’ve simplified their flagship app and also created a strong relationship between the user experience when using digital channels and when physically browsing the stores.
Over 110 stores have been remodeled, and close to 30 new small format stores were opened in key urban markets, a next-generation prototype store was launched just outside of Houston, Texas.
As I’ve previously mentioned, Target’s focus on investing in its e-commerce has meant that services like Order Pick Up, Drive Up and its next-day delivery service have improved significantly. The company also acquired 2 technology platforms, Grand Junction and Shipt, to unlock same-day deliveries and make it more cost-effective.
After compiling the annual results the figures are definitely not as gloomy as what wall street would have you believe. There are 3 metrics I go by when determining a company’s valuation, these are as follows, CapFlow, CROIC and FCF Yield.
The first is a ratio of the capital expenditures of the business compared to the operating cash flow, as it will show how much the ratio that is free cash flow, and this can be used on dividends, share buybacks, reducing debt, acquisitions or reinvestment to keep growing.
The second is a ratio that uses the free cash flow and divides it by the invested capital, this will show how much cash a company can generate. For example, a company with a CROIC of 20% means it generates $0.20 for each $1 invested.
The third is basically the inverse of the price to free cash flow ratio and turns it into a percentage, historically anything under a ratio of 15 or 6.66% represents fair value and the lower it is the better. For a margin of safety, I usually don’t recommend a company unless we’re getting a 10% yield return on our money.
|Total Revenue (M)||$ 71,279||$ 72,618||$ 73,785||$ 69,495||$ 71,879|
|Operating Income||$ 4,121||$ 3,653||$ 4,923||$ 3,965||$ 3,646|
|Net Income||$ 1,971||$ (1,636)||$ 3,363||$ 2,737||$ 2,934|
|Net Income Margin||2.77%||-2.25%||4.56%||3.94%||4.08%|
|Free Cash Flow Per Share||$ 4.78||$ 4.15||$ 6.96||$ 6.67||$ 7.98|
|Dividend Per Share||$ 1.65||$ 1.99||$ 2.20||$ 2.36||$ 2.46|
|Free Cash Flow Payout Ratio||34.52%||47.95%||31.61%||35.38%||30.83%|
As we can see from the table above, total revenue has remained flat over the past 5 years and the operating margin has decreased by roughly 70 basis points compared to 2013. There has also been an improvement in the companies net income.
What is clearly evident is that the dividend is extremely safe as the company generates a huge amount of cash compared to what it pays out to shareholders. Recently the company has only raised dividends by roughly 3.50% the past few years, and this is something that definitely needs to be addressed, as the company can go up to a 50-60% payout ratio and still be perfectly safe. Investors expect a larger raise when the dividend is only 3.50%, anywhere from 6-8% would be reasonable. We’ll be able to find out what the next raise will be when the company reports its Q2 figures in June.
|Year||Cap / Flow||CROIC||FCF PS|
You can see that capital expenditures have decreased recently and this has created the vast amount of free cash flow the company now enjoys. For example, the company generated $4.4 billion in free cash flow in its 2017 annual report, while dividends paid out only cost $1.34 billion. This leaves the company with a vast amount of money for the things I mentioned earlier.
The return on invested capital is also the highest its ever been, which is why I believe investors are overreacting to recent results and are not looking at the bigger picture. The free cash flow per share has increased by a massive 67% within that 5 year period. One of the reasons is that the company has started to repurchase its own shares.
The main negative over the Q1 figures reported on May 23rd was that the operating margin fell by 90 basis points from 7.1% to 6.2% when compared to the same quarter last year. The strongest traffic growth in 10 years and improving its digital sales, which should help cut costs and keep margins steady.
The company has boosted guidance for Q2 and reaffirms full-year expectations, there is nothing for investors to worry about!
In the second quarter, Target expects an acceleration in its comparable sales into the low to mid single-digit range.
For full-year 2018, Target continues to expect a low-single digit increase in comparable sales, and both GAAP EPS from continuing operations and Adjusted EPS of $5.15 to $5.45.
There are only a few companies that can say they have increased dividends for over 50 years in a row and Target is one of them. Its average dividend yield has been 3.20% so you’re getting it at a discount with the yield at 3.50%. The company’s share price suffered last year and it fell dramatically to $48 after a boycott of its stores over its transgender bathroom policy.
Warren Buffett’s “be greedy when others are fearful” quote gave value investors an amazing 40% return to today’s current share price of $71.21. The crazy thing is, with free cash flow of $7.98 per share the company is still ridiculously cheap at a ratio of only 8.92! This gives you a free cash flow yield of 11.21% on your money! I’m recommending you buy roughly 50% of your normal position size and if you’re reading this article late you can buy up to a price of $79.80.
The second half of your position will be reserved for $50 as I’m not a fool and understand where the shares have been recently and could be again, after a 10-year bull market its best to stay conservative and not commit all of your cash to a position.
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