As a dividend growth investor, I am always on the lookout for additional dividend growth opportunities. Some of them already exist in my portfolio, while others are new posts. As we see growing uncertainty in the markets, and we see how volatility is increasing, I am looking for opportunities to find attractive long-term opportunities.
In previous articles, I analyzed both Walmart (WMT) and Costco (COST). I found both companies very appealing, but they were also both expensive. Costco is more expensive but also growing much faster than Walmart. I thought I should revisit one of my older posts in this area, Target (NYSE: TGT) which has more than tripled since I first bought stocks.
I will analyze the company using my dividend growth stock analysis methodology. I use the same methodology to facilitate the comparison of the stocks analyzed. I will examine the fundamentals, valuation, growth opportunities and risks of the business. I will then try to determine if it is a good investment.
According to Seeking Alpha’s business overview, Target operates as a general merchandise retailer in the United States. The Company offers food assortments, including perishables, dry grocery, dairy and frozen, apparel, accessories, home décor, electronics, toys, seasonal offerings, food and other goods.
Over the past decade, Target sales have increased nearly 50%. Sales are growing mostly organically as Target expands by opening more stores, improving same-store sales and expanding its online offering. Investment in online channels has been responsible for half of the growth since 2019. Going forward, analyst consensus, as seen on Seeking Alpha, expects Target to continue to grow sales at an annual rate of about 4% in the medium term.
While revenue growth was modest, EPS (earnings per share) grew at a much faster rate. Over the past decade, EPS has more than tripled. EPS growth was fueled by sales growth as well as buybacks and margin expansion. As the business expands online and improves store efficiencies, operating margins have increased by 12% and are expected to continue to grow. Going forward, analyst consensus, as seen on Seeking Alpha, expects Target to continue to grow EPS at an annual rate of around 8% over the medium term.
Target is a dividend king, which means it’s raised its dividend for more than 50 consecutive years. In June, Target is expected to increase the dividend again, and this will be the 51st consecutive year the company has increased its annual payout. After a 32% increase in 2021, investors should expect a more modest increase of around 10% which will be higher than inflation. The dividend is safe with a payout rate of less than 25%, and the current 1.5% yield is not hugely attractive due to the current rising rate atmosphere.
A dividend growth company generally uses two methods to return capital to shareholders. The first is the dividend of course, and the second is the buyback. Fewer stocks support higher EPS growth and buybacks are more effective when valuation is attractive. Target is aggressively buying back its stock and over the past decade the company has reduced the number of shares outstanding by more than 30%, which has had a significant impact on EPS growth over the decade.
Target shares are trading for a P/E (price to earnings) of 15.43. It’s almost the same P/E ratio it traded a year ago, and significantly lower than the 52-week high. Paying less than 16 times earnings for a company that is showing significant, reliable growth and paying a safe dividend makes sense to me, especially when the growth trajectory is positive like in the case of Target.
The chart below from Fastgraphs highlights the fact that Target is currently priced attractively. The company’s average P/E over the past two decades was closer to 17, and it’s higher than the current P/E. Although the company posted an average growth rate of 11% versus the current average forecast of 8%, I think Target shares are attractively valued as Target is a safe haven in times of uncertainty.
In conclusion, Target seems to be in just the right place. It has strong fundamentals with growing sales and EPS, it uses that income to return capital to shareholders through buyouts and dividends. This excellent package is trading at a price below its average valuation, which makes Target an attractive investment prospect for dividend growth investors if it has enough growth opportunities.
Target’s significant growth opportunity lies in its online and omnichannel capabilities. Online sales grew 21% in 2021 following a 145% increase in 2020. Target is leveraging its store to provide a blended offering that combines the convenience of a store with an easy-to-use app. Its Drive Up service allows customers to order online using the app and have it delivered to the trunk of their car the same day. It’s a competitive advantage it has over Amazon (AMZN) for example, and Target intends to expand this offering in 2022.
Currently, the level of uncertainty in the markets is high. We see high inflation and higher rates and there is a risk of recession for the foreseeable future. When the level of uncertainty is higher, a margin of safety becomes more crucial than ever. Compared to company peers like Walmart and Costco, Target enjoys a lower valuation that gives its investors a higher margin of safety for their investment if the economy continues to slow or even crash.
Target uses a mixed strategy not only when it comes to its distribution channels. $30 billion of the company’s $106 billion in revenue came from company-owned brands. The company combines its brands with the biggest brands in the world. Although it sells its brands, it also cooperates with brands like Disney (DIS) and Apple (AAPL) which have their stores in Target stores. It also cooperates with Starbucks to allow consumers to grab coffee and pastries when grocery shopping.
The first risk is that Target leans toward discretionary spending. Unlike peers like Walmart and Costco which primarily focus on consumer staples, Target’s sales include discretionary items. Therefore, if the economy goes into a recession, Target will be hit harder than its peers, as discretionary spending will be reduced.
Additionally, Target operates in a highly competitive environment. In the consumer discretionary sector, the company primarily competes with Amazon. Amazon’s revenue is five times that of Target, and it has significant pricing power and logistics capabilities. Target is fighting this with its Drive Up offering I described above, but it’s still a significant challenge going forward.
Inflation amplifies the competitive challenge. When companies face inflationary pressures, they tend to raise prices to maintain profitability. However, when competition is tough, rising prices can lead to a loss of market share. Therefore, Target will likely need to become leaner and more efficient to maintain its current profitability while dealing with higher costs. If he succeeds, he will be able to raise his prices more modestly and maintain his level of profitability and market share.
Target is a great example of a traditional company adapting to technology trends and always listening to customer needs. The business is then rewarded with increased demand which results in increased sales. Higher sales lead to higher EPS which, in turn, fuels dividends and redemptions. The company is currently attractively valued and has several prospects for future growth.
In terms of risks, the company must face several risks, mainly market and sectoral. However, the company has proven in the past that it can handle such challenges, and with such a long track record, I’m comfortable investing in Target. Investors can enjoy 8% growth and a growing 1.5% dividend for a total return of nearly 10% with relatively limited risk. Therefore, I believe Target is a BUY in the current market.