Why Target (TGT) is a Buy

The company that I’m about to break down falls under one of my favorite investing strategies – buying hated stocks.

And, as the contrarian I am, this is an incredible investment opportunity right now… that know one else seems to mention.

I’m talking about Target (NYSE: TGT).

Today, Target is considered one of the most hated stocks on Wall Street. As e-commerce companies like Amazon continue to dominate the market, traditional brick and mortar retailers like Target are feeling the pressure…

However, the company is a perfect example of a stock that is currently undervalued and overlooked.

And as the stock price is sitting near 5-year lows, I expect a favorable rebound for investors.

But before we get into any fundamentals, let’s take a look at where this stock is today… and why almost everyone on the street is unimpressed.

Earnings

First of all, Target reported their Q4 earnings last month. How did they do? Horrible. It turns out it was a very disappointing holiday season. And ever since, the stock has fallen way out of favor.

In fact, when the company released earnings, the stock price fell 13%, resulting in their 2nd worst trading day since 1998.

Here were the results:

  • Earnings per share: $1.45 vs. an expected $1.51
  • Revenue: $20.69 billion vs. an expected $20.7 billion
  • Same-store sales (the most important metric): A decline of 1.5%

To put these numbers in perspective, a year earlier, Target earned $1.52 per share based on $21.6 Billion in revenue.

Three months ago the stock was over $75. Now, the price rests just below $54. That’s a quick 30% drop.

My point: The stock has been crushed.

And it’s clear, many investors have grown impatient with Target’s lack of progress.

All of which leads me to my next point…

Wall Street Hates Target

And I think there’s been a bit of an overreaction… But we’ll get to that in a moment.

So how do you know a stock is hated? Well, It’s mostly about the analysts… Not just because the price is down.

All the analysts are avoiding this stock. I mean, I see “sell” ratings everywhere. All the talking heads on TV have negative sentiment. And even the hedge funds are selling.

Let’s take Goldman Sachs for an example…

Goldman Sachs has a sell rating on the stock, claiming that there’s “more pain ahead.” And that basically, they just don’t see changes coming in anytime soon.

Here’s why I’m concerned with that thesis…

Off the bat, I noticed Goldman‘s sell rating of the stock has a target price of $53. Yet, Target is currently trading at $54.

This is why you shouldn’t pay too much attention to sell side analysis. People usually say, “Well, Goldman has a sell on it.”

But you got to look a little further…

If their target price is a dollar lower than the actual price of stock – you have only a dollar risk and all the upside in the world if things go right.

And looking at the bigger picture, there a lot of things that could go right for the company in the next 6 to 12 months.

The risk/reward tradeoff looks favorable.

Let me explain more…

There are a few underlying catalysts that can drive this stock higher. And while the stock price is severely depressed, the time to get on the train couldn’t be better.

Now before I continue and talk about Target’s long-term growth potential, there’s something that I want everyone to know…

A Bumpy Road

It will be a bumpy road until they reach back to normal levels.

But here’s the thing… For a company like Target, just because the stock is hated, does not mean the business model is flawed.

They just need to make changes.

And as investors, we need to know that changes takes a bit of time.

As of today, the company has a lot on their plate.

Here are some examples:

For one, they’re going to try to improve pricing and margins on their products. They are already spending over a billion dollars to do that.

What does this mean?

This means they are having trouble finding the right prices.

Maybe they should raise them… maybe they should lower them…  but regardless, they are having a difficult time finding that perfect price that will help maximize profits.

This is a problem. Yet again, it’s nothing permanent. And it can be fixed.

Then, you have the fact that they have to redesign stores.

Just last month they’ve released new store concept blueprints.

Here are a few examples…

Target Buy

Remember, Target is not 100% in the apparel industry – a sector that’s getting destroyed.

Target Buy

They have exposure to everything else like groceries, electronics, etc…

Target Buy

 

These are changes that we can expect to see rather sooner than later. “As many as one-third of Target’s stores could receive significant makeovers by 2019”. That’s roughly 1,800 stores. There’s more here.

The company will also continue to invest heavily in digital sales.

It’s worth noting that since 2013, Target’s online sales have doubled. This was the only positive to take from their Q4 2016 earnings… Digital sales increased 34% from the previous year.

These are just a few out of the many changes going on. And all of these changes allude to the revamping of merchandise, prices, and how they sell.

Again, it means the stock price is going to be bumpy.

When I see companies like this that are revamping operations almost completely, that means they’re going to test a lot of things.

And they’re going to be wrong on a few things before they find out what actually works.

Thus, I do foresee a couple of weak quarters going forward.

On the bright side…

Now I know what you’re thinking.

Why should I buy stock of a company that is making drastic changes… a company that everybody hates… and a company that doesn’t expect to see results from these changes for another 2 years at least…

Well, there’s a couple things to mention…

For one, the company’s stock price is extremely depressed.

And as the price comes down, the yield percentage, which is based on that, goes higher.

So the dividend-yield is over 4%. 4.48% to be exact.

This is a huge factor.

And when you see a yield over 3.5%, especially when it hits 4%, you want to make sure the company can pay it.

And Target can. It will cost only the company $1.3 billion.

To put that into perspective, their operating cash is over $5 billion.

What does that mean? What are they going to do with that extra capital?

Something called capbacks.

They’re going to be spending to improve the business longer term, but they’re also going to take a large chunk of that to buy back their stock.

And it looks like they have enough cash to do so.

Here’s another big catalyst…

Insiders are buying the stock.

This is something I love to see.

We didn’t see it with Under Armor (UA). Which is down 60% off its highs.

I mean, why should you buy the stock if it’s 60% off its highs? …Especially if the owner’s are not buying it.

But for Target, you have the CFO and Executive Vice President purchasing half a million dollars worth of stock.

This was just 1 month ago.

Even better, they bought the stock at $58. What’s the stock at right now? Just below $54.

So if you’re buying today, you’re going to get it at a better price than these guys and they are the guys that know the most about the company.

Valuation

Target is trading at just 13 times forward earnings.

This is pretty cheap.

You’re looking at a company that’s much cheaper than the market.

But here’s the best part…

That 4% yield.

If you buy Target here, you’re pretty much getting paid to wait.

It won’t matter if it takes two years before the stock finally takes off from these initiatives.

You’re getting paid 4% a year which is 10 times better than putting your money and parking it in almost any place in the world.

Also, you know the dividend’s safe because they’re generating tons of cash flow.

Looking at Target in the near future…

They’re probably going to miss next quarter. They might even miss the quarter after too.

But what is it going to go down to? 10 times forward earnings? 11 times forward earnings? …I don’t think so.

Now don’t get me wrong, if they report earnings that are 40% lower than expected, the stock’s going to get crushed and you’ll have to revalue it.

However, I believe if you close your eyes, and you open them in two, three years… You’re going to make 30%, 40%, 50% on this stock with very little risk here unless they completely blow up.

A look at all the downside protection

  • Goldman has a $53 price target on it and it’s only a dollar lower than the actual price.
  • You have insiders buying at 4 dollars higher than what the stock’s trading now.
  • You have a company with a 4% yield, which people are going to be craving for.
    • By the way, the whole world’s craving for yield. This is also going to push money into the stock.
  • They have enough cash leftover to buy back shares if it pulls back.

All of this is like putting a floor (not a ceiling) underneath the stock for you.

Let management do their thing.

And see if these initiatives work, which they tend to eventually.

And then let’s not forget, Target’s a huge company.

They’ve been around for decades and these companies tend to figure it out. This is a company that is always in the same sentence as Wal-Mart.

Sometimes it takes longer than expected to turn things around. But if it does take longer, at least you’re getting paid that 4% yield.

So from a risk/reward standpoint, is this stock going to go up 100%? No.

But if you’re looking for income and you’re looking for the potential of long-term growth, Target’s a really great buy here.

I like their growth initiatives and again, you’re getting paid to wait.

Links & Resources

Stocks Mentioned

  • Target (TGT)
  • Wal-Mart Stores (WMT)
  • Under-Armour (UA)

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5 Comments

  1. Bernard Hayden MD
    April 10, 2017 @ 1:04 am

    Something you may not know about Target, Frank, is that they have 1.5 MILLION customers who are actively BOYCOTTING them over their open dressing room/bathroom policy. And those are the people who have actually signed the boycott request through AFA. I would bet there are millions more who haven’t gone to the trouble of signing but are staying away until the problem is corrected. I really can’t believe the Board hasn’t fired the CEO/CFO since they have admitted their policy is a mistake but have done NOTHING to correct it. Unbelievable. I sold all my stock when the issue first arised and would love to buy back in but I’m not about to until something drastic changes in the top echelon.

    Reply

  2. John Zimmerman
    April 11, 2017 @ 1:05 pm

    Good analysis leading me to a buy at this time. Dividend yield at 4.48% is a definite advantage if they continue to pay it. The diversification of products for sale in each store with the planed improvement in presentation is also a plus.

    Reply

  3. Latest Buy — Target – Two Investing
    April 15, 2017 @ 10:14 pm

    […] I was going to be purchasing more TGT regardless, this article, Why Target (TGT) is a Buy, from one of my favorite investment guys, Frank Curzio, sealed the […]

    Reply

  4. Scott
    April 15, 2017 @ 10:18 pm

    Frank, thanks for the excellent write-up! I purchased more TGT before reading your analysis, but like to see that we’re on the same page! Keep up the good work here. And, glad to hear that your new business is successful. Thank goodness I didn’t put any significant money down on your March Madness picks though!!

    Reply

  5. Mike
    April 17, 2017 @ 12:06 am

    I haven’t stepped foot inside a target since they made their announcement about their bathroom policy. I used to go once or twice a month. I didn’t sign the boycott, so i’m one of the many who just won’t shop there. I believe this is a good reason to stay away from the stock as well.

    Reply

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