Target Corporation (NYSE: TGT ) increasingly looks like a binary stock. From current levels just below $70, Target stock very well could soar.
Accelerated sales growth will drive operating leverage and even faster earnings growth. Renewed confidence will get TGT stock back to previous earnings multiples. There's a reasonable path for TGT to clear $100 in 12-24 months in that scenario.
It's also possible - maybe equally possible - that Target stock will tank. Same-store sales growth at least was positive in fiscal 2017 (ending January 2018). But at 1.3%, against a 0.5% decline a year ago, it's simply not enough, even with a strong fourth quarter .
Those omnichannel investments will further pressure operating margins, which fell 110 bps in FY17. With those margins at just 6%, another ~100 bps of pressure cuts EPS by roughly 20%. A low double-digit multiple in line with a weaker department store retailer like Kohl's Corporation (NYSE: KSS ) and EPS in the $4 range gets TGT back toward $50.
Assuming both scenarios are equally likely, Target stock would seem modestly undervalued at current levels. But for TGT stock to be a compelling pick, I'd like to see it trade for much cheaper.
I still don't trust the retail space, and the omnichannel-driven struggles at larger rival Walmart Inc (NYSE: WMT ) show just how tough the transition from brick-and-mortar leader to online competitor can be. Target has a path to upside, but to take on the risks, I'd like to see the reward be a bit bigger.
The Case for TGT Stock
There's a clear case to buy TGT stock on the dip back below $70. The stock trades at barely 13x the midpoint of FY18 EPS guidance of $5.15-5.45. Comparable sales improved in fiscal 2017, including a solid 3.6% print in the key fourth quarter.
And there are a lot of initiatives and investments that should drive sales growth going forward. Target now is offering free two-day shipping, a clear attempt to compete with Amazon.com, Inc. (NASDAQ: AMZN ) and its Prime program.
On the Q4 conference call , COO John Mulligan said the company actually would do much of its shipping from stores, rather than dedicated fulfillment centers, which Mulligan argued would be cheaper and more efficient.
Same-day shipping is also expanding, and Target will offer delivery for in-store shoppers as well. Store remodels are expanding. Savings from tax reform are going back into the business, with Target raising its minimum wage to $12 on the way to $15 by the end of the decade.
From a qualitative standpoint, Target is trying to make the shopping experience better. Better-paid workers should (in theory) reduce turnover and improve service. Target can meet shoppers online or in store. Remodels should boost traffic and help sales.
Customers should want to shop at Target, which means the company can compete better not only with Amazon and Walmart, but Kohl's and Dillard's, Inc. (NYSE: DDS ).
Add to that customers poached from declining retailers like J C Penney Company Inc (NYSE: JCP ) and Sears Holdings Corp (NASDAQ: SHLD ), and there's a lot of reason to see sales growth accelerating over the next few years.
And from a quantitative standpoint, if that growth accelerates, margins are going to expand, and EPS should clear $6 at least. Slap on a conservative 15x multiple, and TGT stock is heading toward $100, 40%+ upside.
The Case Against Target Corporation Stock
The broad concern here is that the retail space simply remains so tough. And Target isn't performing that well - yet. Operating income declined 13% in FY17. EPS is guided to increase about 12% year-over-year in FY18 at the midpoint, but all that growth is coming from tax reform. Pre-tax earnings likely will again decline in FY18, at least if Target hits guidance.
Meanwhile, even with the recent spend and the new initiatives, Target still is guiding for just low single-digit same-store sales growth next year. That's not enough to leverage increasing labor and rent costs.
Because retail has changed so dramatically over the past few years, any positive comp number sounds decent, but it's not. Generally speaking, same-store sales below 2% lead to declining profits. That doesn't even include the margin pressure from omnichannel efforts, which are required to compete with Amazon and Walmart, but are expensive.
And the Walmart example is instructive. Just a couple of weeks ago, Walmart's own e-commerce efforts were being lauded, and the company was being posited as, finally, a real competitor to Amazon. Walmart's Q4 report changed that narrative dramatically . Target is trying to do the same thing but from a smaller base.
It's possible, and if it works, the upside is huge. A 3.5% dividend yield helps the case as well. But possible isn't guaranteed, or even likely. Toward the low $60s, the risk/reward for TGT stock looks more compelling.
At the moment, the market is pricing in a reasonable likelihood that Target sees significant success in e-commerce. Given how few brick-and-mortar retailers have been able to pull that off, I'm reluctant to take that bet without much better odds.
As of this writing, Vince Martin has no positions in any securities mentioned.
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