Target (TGT) Is Still Undervalued

Target (TGT) is Still Undervalued. For the last five years or so, the demise of retail brick-and-mortar establishments has been predicted. Every year, it appears that a large number of brick-and-mortar stores have shuttered their doors. Thirty store chains have filed for bankruptcy in 2020, according to retail diving. Guitar Center, GNC, J.C. Penney, and Neiman Marcus are the ones you may have heard of. Retail customer experience is developing, according to retailcustomerexperience.com, and companies focused on authentic in-store experiences will succeed. Target (TGT) is one of them as you will see the company has developed key online value adds to their stores. Target is growing by driving traffic and volumes during the pandemic. The stock price is up ~65% in the past 1-year but Target is still undervalued.

Target’s Move Online

Most people think of Target as just a physical shop, but the retailer now has an online presence that is rapidly growing. When it comes to online experiences, it appears that Costco (COST), Walmart (WMT), Target (TGT), and CVS (CVS) have taken some of Amazon’s market and established a niche. Target has been one of the hottest retail companies in 2021 during this period, outperforming Amazon (AMZN) , Costco, Walmart, and Home Depot (HD) over the previous year.

During the pandemic, Target’s hybrid strategy of a bricks-and-mortar shop with a continuous online presence was a popular mix with customers. Target’s same-day fulfillment approach, which merged grocery and discretionary shopping, also had exceptional results. Target’s fulfillment centers/stores are now able to produce additional income and operational leverage as a result of this increased online retail capability. Amazon and Walmart are unique in that they both have their distribution hubs for the majority of their online orders. Rather than relying on distribution hubs, Target relies on its stores which is a less expensive and a much speedier option.

Omni-Channel Retailer

To cut it short, Target doesn’t care whether you went into the store since the value was in its capacity to use its locations as delivery facilities. Drive-up/pick-up, Shipt/same-day delivery, and shipping online are the three primary digital services they provide. All of which leverage their brick-and-mortar strategy. To give you an idea of how well these services performed in the second quarter, they were able to expand their parking lot pickup services by 80% year over year. Sales of Shipt services grew by 30% in Q2 2021 after growing by 350% the previous year. Whether or not there is a pandemic, these numbers will probably continue to rise in the future since customers enjoy these unique experiences at Target. Imitation is sometimes the greatest form of flattery, and Amazon is increasingly going into physical retail.

Target Q2 2021 Highlights and Guidance

Target was able to maintain operational leverage of 9.8% in the first half of 2021, which is extremely high for the company. As a result of the easing of COVID-19 restrictions, Target’s management team anticipates margins to fall dramatically over the following two quarters, to 8% for the whole fiscal year. In this article, I’ll show you why Target is still an undervalued long-term investment if you want to add a retail behemoth with a rapidly expanding online business to your portfolio. In comparison to the market and other big-box stores, I feel this is still undervalued. And, according to the DCF model I created, the stock is still relatively cheap in the long run. I believe people are underestimating the capacity of internet growth to subset COVID-19’s unsustainable demand. 

Target’s Valuation

In part of the article, I utilized four alternative methods to assess the business’s fair value. To begin, there is a DCF perpetuity model, an exit multiple, a comp model/basic metrics, and a dividend discount model. Individual portions of the next paragraphs will describe how each of these models works, in general, to help you comprehend the results. The models will show you why I think that Target is still undervalued.

Target Comp Model

In terms of this valuation method, I came up with a list of comparable companies that serves a similar market to Target. Walmart, Costco, Dollar General (DG), CVS, and Amazon were among the retailers I considered. When comparing EV/EBITDA multiples, Target is less expensive than Walmart, Costco, Dollar General, and Amazon. As a consequence of utilizing Target’s EBITDA and multiplying it by an average of my comp firm multiples, the estimated price per share was $400.32. Target is less expensive than Dollar General and CVS in terms of EV/REV. Using the average of my comparable companies’ EV/REV and multiplying it by Target’s revenue, I arrive with an estimated price per share of $309.12.

Target Exit Model

The firm is selling for less than virtually all other comparable companies, except CVS, according to the price-to-earnings ratio. The PEG ratio, which considers growth in profits, is another metric I used to compare Target to. Looking at all of these comparisons, Target appears to be the cheapest of the companies when taking into account the earnings growth. The stock is valued at 50 P/E if you consider last year’s earnings before the 20%+ increase in revenue. This is substantially greater than when the pandemic net profit margin is included in. I would purchase this stock all day if you felt they would be able to expand on the demand (subset the displaced growth from other areas) and discovered something truly innovative with Target’s internet/hybrid part of the business. 

Target Dividend Discount Model (DDM)

Due to Target’s poor dividend growth rate and tiny average payouts, the Dividend Discount Model believes the company is overpriced. It calculates this by multiplying the previous full year’s payouts by the average growth rate divided by (WACC – average growth). Although it’s good to know, Target’s payout ratio is very safe at 38.22% which, offers potential expansion in the future if the business stagnates or expands. 

Target’s dividend growth rate has slowed from a double-digit rate earlier in the past decade to low single-digits as seen the chart below from Portfolio Insight*. The trailing 5-year dividend growth rate is 4.41% CAGR and the dividend growth rate is 12.3% in the past decade. The low payout ratio indicates that the dividend is not at risk from an earnings perspective and will likely keep growing in the foreseeable future.

Target Discounted Cash Flow Model

The company’s free cash flow and the discount rate, which is computed using the time value of money, are both crucial to know when it comes to the discounted cash flow valuation analysis. To grasp this, consider the difference in value between receiving $100 today and receiving $100 in five years. There is a big difference because of the opportunity that receiving that money today would allow you to use to grow your capital. In this model, I have a bearish and bullish approach in my model, which I weigh differently depending on how I think the business will do.

My bullish assumption is that revenue would increase by 4% every year, which is historically low when compared to the trailing average. Although this is an assumption, there is significant danger in doing this because 2020 was a significant growth anomaly, and raising it more may cause valuation risk problems for the model. As for the bearish model, I didn’t increase revenue until 2021 – 2022 by 4%. Then, every year for both models, I gradually increased COGS by 0.15%. Another assumption was that I assumed a 2.07% annual rise in depreciation, which is modest when compared to the average. In the Capex line, I assumed a growth rate of 2.5% to 4%. 

Bullish 70% Weighting

Bearish 30% Weighting

To determine Target’s beta, I took the leveraged beta of the competitor’s businesses and unlevered it by removing its capital structure, leaving only the business risk. I then took that same beta which I averaged across all the comps and relevered the beta to Target’s capital structure. 

The perpetual growth (bullish DCF) was valued at $286 per share as a result of these main components and important assumptions. Using the terminal value exit multiple, which is a basic multiple model that involves multiplying the most recent EBITDA by a multiple based on the industry average of 12x EBITDA. As a result, the equity per share is $309, according to my calculations. Looking at the bearish approach, the perpetuity model determines an estimated $219 per share, and the multiple models are $264.88. Taking the weighted average of the 70% bullish and 30% bearish scenarios of the perpetuity model the stock is worth somewhere in the range of $265 – $300 fair intrinsic value range today. The current stock price as of this writing is $244.65.

Final Thoughts on Target (TGT) is Still Undervalued

As a result, I feel that the long-term Target is still discounted and undervalued in comparison to its peers and, as a result, is quite inexpensive. As a result, if you want to own a large-cap retail company in your portfolio with good dividends, I feel I would buy Target for a long-term hold. Target is a Dividend King with 54 years of consecutive increases. The market is significantly discounting its ability for its online services to displace its potential lost growth during COVID-19. 

You can also read 3M Stock Today by the same author.

Disclosure: The author does not have a position in Target.

Author Bio: TK is a 21-year-old student studying finance in college seeking a job in finance. He enjoys learning about disruptive stocks and businesses in his free time. He specializes in valuation and M&A.

Disclaimer: It is also important to note past performance does not equal future performance.

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