Should You Hold Target (TGT)?

The past few years have been a rollercoaster for Target (TGT). 

Pandemic-fueled buying sprees left the company with mountains of unsold inventory, forcing aggressive markdowns. 

Simultaneously, a surge in theft and organized retail crime – dubbed “shrinkage” in industry parlance – has taken a significant bite out of profits. 

In 2023, Target estimated shrink could cost the company up to $1.3 billion in lost sales.

It’s why shares of the retailer are down more than 40% from their all-time highs, while competitors like Costco (COST) and Walmart (WMT) set new heights every day.

But things could finally be turning around for the Minnesota retailer.

Financial pros actively searched out the stock after its earnings release on the 21st, as EPS and revenue handily beat estimates.

Comparable sales increased 2.0%, the first positive growth since Q1 of 2023. Lower shrinkage improved gross margins by nearly 1.0%.

It’s got long-term investors wondering if things have finally turned the corner.

Here’s what we think.

Target’s Business

From stylish home goods to grocery essentials, Target aims to be America’s one-stop shop for bargain hunters with an eye for design, operating over 2,000 stores across the U.S. 

For many millennials, it was their home away from home.

The retailer’s “expect more, pay less” mantra has long resonated with budget-conscious shoppers seeking a touch of flair. 

However, that promise has been put to the test as Target navigates a complex retail landscape.

Target segments its business into the following areas:

• Beauty and Household Essentials (26% of total revenues) – Makeup, cleaning supplies, and everyday necessities.
• Food and Beverage (20%) – Groceries and drinks to keep America fed.
• Hardlines (16%) – Electronics, toys, and sporting goods for work and play.
• Apparel and Accessories (20%) – Fashionable finds for the whole family.
• Home Furnishings and Décor (18%) – Stylish touches for every room.

Management was upbeat as the company beat on top and bottom line estimates in its latest earnings release.

Source: Target Q2 2024 Earnings Infographic

The company’s aggressive stance on shrinkage appears to be paying off, with inventory loss lower than expected. 

However, Target remains cautious, acknowledging that regaining lost ground in discretionary categories like home goods and electronics will take time.

Target’s digital strategy has emerged as a bright spot, with services like Drive Up and same-day delivery seeing double-digit growth. 

The retailer is betting big on its revamped loyalty program, Target Circle, to deepen customer relationships and drive sales. 

Financials

Source: Stock Analysis

Target’s sales slipped in the last two years as foot traffic decreased without digital sales increasing to compensate.

At the same time, theft and bloated inventories crimped gross and operating margins.

While a few percentage point drop might not seem like much, remember these retailers work with high volume on thin margins.

Cash flows were hit particularly hard as operating cash flow crashed from $10.5 billion in 2021 to $4.0 billion in 2023. That same year, the company spent $5.5 billion on CAPEX, making it their first year of negative free cash flow in over a decade.

Since then, things have dramatically improved, with operating cash flow exceeding $8.5 billion.

Total debt sits at $19.5 billion, which is certainly higher than the $13.8 billion on the books before the pandemic. However, interest expenses come in at just $500 million, largely in line with where they’ve been for the past decade.

While Target still pays a 2.8% dividend, it suspended share buybacks to invest in its operations.

Valuation

Source: Seeking Alpha

Target’s problems have made the stock cheap relative to its peers.

It trades at half the P/E ratio of Walmart, and is even cheaper than Dollar General (DG).

In fact, the only company cheaper on most metrics is Dollar Tree (DLTR).

Growth

Source: Seeking Alpha

When we look at Target’s growth metrics, we can see why it has gotten so cheap.

Revenue growth has been non-existent, while cash flow and earnings have shrunk in the past few years.

Compare that to Costco or Walmart, who’ve seen consistent gains in sales and profits over the past three years.

Profitability

Source: Seeking Alpha

The good news is Target’s finally seeing its margins improve.

Gross margins now exceed Walmart’s, while net income is at the top of the group, as is free cash flow.

This helped it achieve the return on equity amongst its peers and the second-best return on total capital.

Our Opinion 6/10

We expect Target’s efforts to improve operations will continue to yield results in the near-term.

However, weaker consumer spending will likely offset those gains.

The real question is whether Target can find a way to deliver true growth as it once did.

On that, we aren’t sure.