We last wrote about Target (TGT) in May, citing considerable upside potential – since then shares have run up over 30%. Our thesis was primarily built on an unjustified discount being applied by the market due to temporary margin headwinds. We continue to believe that Target is a quality brick-and-mortar retailer and although valuation has run up in the past several months, we believe this is also justified given their recent Q2 results.
We reiterate our buy rating on Target, and continue to believe long-term performance will remain fairly stable warranting a premium in the current environment. Recent quarterly results reinforce this.
Retail Performance is Widespread
Target operates as a brick-and-mortar retailer selling a wide variety of merchandise. Other companies selling general merchandise include superstores like Walmart (WMT) and Costco (COST). Retail has experienced heavy impacts as COVID-19 swept the country – many department stores were forced into bankruptcy while grocery stores saw temporary tailwinds. Going forward, we believe the industry’s performance will be category-dependent.
Declining foot traffic continues to be the case at department stores, and we don’t expect that to change all that much. On the other hand, there has been fairly stable – if not positive – year-on-year performance at specialty retailers in the home improvement and grocery space. Placer.ai presents an interesting picture of retail performance throughout the pandemic, by category.
Adding on to the stable brick-and-mortar business, Target is also benefiting from efforts on the e-commerce front. With initiative like Buy Online, Pick-up in Store (BOPIS) and delivery through platforms like Shipt, they are able to service demand more efficiently than before. We believe this will be critical going forward and can help Target maintain their position, or even ramp up share.
Target Continues to Perform
Quarterly revenues have been growing in the single-digit range pre-COVID but have experienced acceleration in the most recent quarters. Although we don’t believe these top-line growth levels to be sustainable over the long run, there is a net benefit to this performance and it better positions the company going forward.
Looking down the road, we believe revenues can continue growing in-line with historical rates, or higher in the short-run. We can see FY2021 revenue coming in higher than consensus estimates at around $90 billion. Margins have historically hovered in the low-to-mid single digit range, but experienced heavy compression into the pandemic. After digging into the reason behind margin compression, we believe that compression would be temporary and that the margin profile would recover over time. Today, net margins sit in the 4% range.
The company’s earnings multiple has expanded in the past several months, and today sits in the low-20s. Valuations in the peer group turn up a median of ~25x earnings, with the best-in-class superstores trading above that. We see today’s valuation as more than reasonable, and can see Target benefiting from the current retail climate. We’re optimistic on the company’s strong initiatives across in-person and online retail channels.
Applying the peer median of ~25x earnings on our estimated net income for the following fiscal year, we arrive at an implied equity value of around $90 billion. Today’s market capitalization sits around $78 billion, indicating potential upside of over 15% in the next year. In the long run, the business continues to make investments which will strengthen their positioning in the retail landscape. In an investment landscape like the one today, we see Target as a quality option.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.