We previously expressed concern that Target Corp (NYSE:TGT) is facing significant competitive pressure. Recent financial results and the strong performance in the all-important holiday season suggest that Target is winning the competition.
We believe that increasing engagement with shoppers at a time when technology and shopping behavior are changing rapidly could be a good indicator of future customer loyalty.
Comparable sales increased 20.7% in 3Q. Target’s traffic was even significantly stronger than we saw at Walmart, which had an excellent 3Q. We believe that the outperformance at TGT is a sign of rapidly increasing relevance to customers that will continue in the holiday season and beyond. Target’s holiday comps were up 17.2%.
The TGT shares are near a 52-week high, but our analysis suggests that there is potential for additional upside.
Football is a game of inches. Retail is a game of traffic. Traffic has been a keystone of our sector thesis for years. Strong traffic is a key reason for our BUY rating on Costco and declining traffic is the reason we have been cautious on department stores. Increasing relevance and convenience should lead to stronger comparable sales than we have been modeling. We recently raised our estimate for average annual sales growth to about 4% annually from 2% annually over the next five years. The performance may be a little bumpy lapping this year’s super-strong results, but Target’s strength at a time when a big swath of the retail market is struggling could lead to additional market-share gains. We expect the incremental sales to help the company to offset rising costs for wages, benefits and healthcare, and leverage depreciation. We expect curbside pick-up to improve the economics of online orders. This should boost net income and cash flow by more than we previously expected. The extra cash should allow TGT to repurchase more shares than we modeled, further enhancing EPS. At the end of calendar 2020 we raised our five-year annualized growth rate to 7% from 3%.
Target’s potential for stronger and possibly more efficient cash flow generation has two other benefits within the Argus Six-Point System. We expect FY21 debt to be less than 2-times EBITDA plus rent.
What is a near-term catalyst for the shares at current levels? Target has made it easy to place an online order, drive to the store and have an associate put everything in the back of your car.
We still expect Target to benefit from market share gains and its increasing convenience. We think spending on health, cleaning and pet supplies is likely to remain strong, but if consumers spend less on so-called consumables Target has a good offering of higher-margin discretionary merchandise that delivered strong results over the holidays. We’d expect spending on home decorating to remain strong and we may see better sales of
clothing. Target should benefit from market share gains with so many specialty chains under final pressure and we could see improvement in the lagging apparel category as kids spend more time at school and grownups return to offices, gyms and beaches. Target will also be opening Ulta Beauty shop-in-shops beginning with 100 in 2021.
There are three components of our Six-Point System that we emphasize for retailers. This is an all-in-one indicator of the company’s earnings power, financial strength, competitive position and management effectiveness. Strong traffic is an indicator of management quality and competitive position. We use performance in the hyper-competitive holiday season as a test of the company’s marketing and merchandising skill. On this basis Target appears to be well positioned for the next 12 months.
On January 13, Target provided an update on holiday sales. Comparable sales for the company were up 17.2%, with comp store sales up 4.2% and digital sales up 102%. That is a very impressive comp increase for a big mature business with about $90 billion in annual sales.
The 4.3% traffic increase certainly supports our bullishness on the company’s relevance to its customers. Average ticket increased by 12.3%.
Sales in the Home category were up in the low 20% range. Hardlines were up by the same magnitude with impressive growth of more than 20% in electronics.
Target’s growth more than doubled the surprisingly strong 8.3% growth in overall holiday sales reported by the National Retail Federation. We need to define some terms. This tally is for the months of November and December. The underlying data is from the Commerce Department’s monthly report on Advance Retail Sales. The number is on a year-over-year basis and excludes sales at automobile dealers, gas stations, and restaurants. This is the way the NRF calculates retail sales and this was the basis for our 6% forecast. One major factor was that restaurant sales were down about 20%. This is a big category and much of the spending was transferred to grocery stores because people ate more meal at home.
Two of the biggest contributors to the overall retail sales growth were the Online category, which was up 23.9% and building materials which was up 19%. Target outperformed the overall furniture and home furnishings category, which was up 2.2%, as well as the overall grocery (+9.6), electronics and appliances (-14.4) and clothing & accessories (-14.9)
General merchandise stores were down 0.1% overall, which suggests that Target gained a bunch of market share with a 17.2% comp. Shoppers seem to be consolidating trips to a small group of trusted retailers. We have found Target’s ordering and drive-up service to be fast and very convenient.
EARNINGS & GROWTH ANALYSIS
We are now modeling a 4Q increase of 16% compared with 12% previously.
This reflects the impressive 10% operating margin in 2Q and 8.55% in 3Q. The company’s guidance, before it was withdrawn, called for full-year EPS (both GAAP and non-GAAP) of $6.70-$7.00.
We are raising our sales forecast for the year and boosting our estimate of operating margin to 6.7% from 6.6%. We are not expecting EPS to increase from FY21’s strong results, but this is a stronger performance than we had been modeling and a nice increase from pre-pandemic levels in FY20.
While we will not formally initiate a FY23 estimate until the company reports 4Q21 results we are currently modeling EPS at about $9.45, up from $9.25 previously.
We raised our sales forecast to about 4% from 2%.
There were three drivers to the increase in our sales forecast. The first is that Target is winning on convenience. There is evidence in its performance and verified by our visits. We have talked about the convenience of its returns. That has continued with their Drive Up service. People who use the service are buying more from Target. We think the convenience will change shoppers’ behavior. The second factor is that we believe consumers are, and will continue to, concentrate their shopping with a smaller number of trusted retailers which offer a wide range of products. This group also includes Walmart, Amazon, Home Depot, Lowe’s and Kroger. These big retailers got a gift when they were allowed to stay open during the first phase of the pandemic and we expect them to fight hard to maintain it. Their size gives them the ability to expand in their existing technology and logistics and it allows them to sell a wider range of products to their customers. We also expect Target to benefit from consolidation in retail. TGT will work really hard to convert the traffic it is getting from food for
humans, food for pets and cleaning supplies into traffic for higher-margin discretionary items which should give their growth legs after the pandemic. Target is already a destination for toys and they should have an opportunity to win more share in apparel. We have quibbled that the home merchandise hasn’t quite been ‘Tarjay,’ but we expect that home will continue to be a hot category and there are a lot of people who either can’t afford Williams-Sonoma and Pottery Barn or recognize that they can stretch their budget by supplementing their higher-end purchases with lamps, pillows, side tables and accessories from Target. Target has a good track record with special collections which recently continued when shoppers get up in the middle of the night to grab a limited offering from Studio McGee.
FINANCIAL STRENGTH & DIVIDEND
The bonds were issued for general corporate purposes.
On November 18, 2020, Target announced that it had terminated this supplementary facility.
Debt was a very reasonable 53% of capital.
Based on our current estimates, we expect debt to be less than 2-times EBITDAR for FY21.
Management’s goal is to pay out about 40% of earnings as dividends while maintaining credit ratings in the middle single-A range.
In the 3Q earnings release, TGT announced that it lifted the suspension and would consider buybacks after the holidays. At the end of 3Q, Target had an authorization of $4.5 billion.
The company’s capital priorities are to invest in growing the business, pay a competitive dividend and increase it annually, and maintain credit ratings in the middle of the single-A range. If the company has excess cash after meeting these goals, it intends to buy back shares.
MANAGEMENT & RISKS
Target should also benefit from having convenient curbside pick-up where an associate brings your order directly to your car.
In the COVID crisis, food has given the company a reason to be open, which has been tremendously important.
We have been hearing that during the pandemic shoppers have had an aversion to debt, using debit cards more and credit cards less.
The company said that while the breach was significant it did not materially hurt results.
On October 9, 2019, Target announced that Michael Fiddelke would become CFO, replacing the very able Cathy Smith who announced, in January, her plan to retire. Ms. Smith was 55 when the prior annual report was published. She remained as an advisor until May 1 of 2020. Mr. Fiddelke has spent more than 15 years at Target, most recently as Senior Vice president of operations. Before Target he worked at Deloitte.
The company announced the resignation of chief merchant Mark Tritton who became CEO of Bed Bath and Beyond on November 4 of 2019. Christina Hennington and Jill Sando who
have almost 40 years of combined tenure at TGT have assumed leadership of the merchandising organization. Ms. Hennington in now Chief Merchandising Officer of consumer staples, beauty, hardlines and services. Ms. Sando is Chief Merchandising Officer for private-brand sourcing, design and brand management in addition to her current portfolio of apparel, accessories and home. They will collaborate with Stephanie Lundquist, the company’s EVP of Food and Beverage.
The company announced in January of 2020 that Chief Stores Officer Janna Potts is retiring. She has been replaced by Mark Schindele, he was previously in charge of Properties, including the small stores that we like so much.
Sales on Target.com represented about 8.8% of the total in FY20, up from 7% in FY19, 5.5% in FY18, and 4.4% in FY17.
We recently raised our five-year annualized growth rate to 7% from 3% based on a stronger outlook for market share gains, sales growth and share repurchases. Based on improving financial strength and competitive performance we are recently reduced our cost of equity to 6.75% from 7.5%.