Target (NYSE:TGT) has paid dividends since 1967. On June 9, 2022, the company announced a 20% dividend increase, giving it a forward dividend yield of 2.62%. Do changing consumer preferences and high inflation rates justify this bold move? Given Target’s declining cash, is this dividend sustainable? Is management sacrificing stock buybacks for higher dividends? Target sells 80% cyclical discretionary goods; is it an excellent long-term investment? This article answers these questions.
Target’s performance relative to the market since 2009 has increased.
Target (NYSE:TGT) fell behind in 2017 as other large e-commerce, and brick-and-mortar retailers expanded their online presence. Target has since renovated its stores to serve as online fulfillment centers. Target’s comparable store sales grew double digits in 2020-2021 as Covid-19 hit, and it stayed open.
Target (NYSE:TGT) sales depend on discretionary items. Apparel, beauty, home furnishings, and other durable goods account for 80% of sales. Unlike Target, Walmart sells 56% of its total revenue in food products. People forced to stay home during the pandemic shopped for Target’s sports, home decor, and beauty products.
Now comes the difficult part. Middle-income households will cut discretionary spending as the economy has reopened and inflation looms. Already facing tough comparisons, Target’s comparable store sales grew 3% in the last two quarters. Food is a crucial anchor category that drives store traffic. With a small food footprint, Target’s traffic will likely drop in the coming quarters.
Target (NYSE:TGT) and other retailers were caught off-guard by changing consumer preferences in 2022 and have excess inventory. Target expects third-quarter inventory charges of $200 million. The company’s management was optimistic about food, essentials, and beauty products. Appliances, sports equipment, home furnishings, and apparel/accessories account for almost 55% of the company’s sales, so they will likely drag down its bottom line next year.
These gravitational forces will impact Target’s stock price over the next year. Target (NYSE:TGT) is likely properly or slightly overvalued at its current stock price and in the absence of positive news.
Table 2 shows Target’s historical valuation from 2020 to the present. Target’s profitability appears to be normalizing. Target is overvalued by historical standards, especially pre-2020 numbers.
Target (NYSE:TGT) return on total capital is much higher than the sector median. TGT’s near-term revenue, EBIT, and earnings growth will lag behind its peers.
While analysts’ long-term EPS growth projections are strong, this indicator is likely noisy and subject to fluctuations. Target is undervalued compared to Walmart, one of its main brick-and-mortar competitors. Profitability fluctuations are expected due to Target’s reliance on discretionary spending.
Walmart’s EV/EBIT and EV/EBITDA are higher due to its more stable business, which sells necessities primarily. This is despite TGT’s better TTM profitability metrics.
Investors: Know Target’s Dividend!
Target (NYSE:TGT) has raised its dividends for 10 years and pays them quarterly. Due to lackluster performance, growth slows around 2016-2017.
Target (NYSE:TGT) raised its dividend by 20% in 2022. This is a signal from management that they expect to earn enough to afford the raise. Target’s payout ratio is 40%. TTM payout ratio is in line with average, but the recent dividend hike and lower profits may temporarily increase it above 40%. TGT’s 2.3% dividend yield matches the consumer discretionary sector.
Target (NYSE:TGT) also buys back shares. The company spent $7.3 billion in the past year, yielding shareholders 9.67%. I doubt the company will cut or stop dividends. With pandemic windfall cash disappearing so quickly and cash balances falling from $8.5 billion in FY2020 to $1.1 billion by July 30, 2022, something will have to give. With this dividend hike, small cash balance, and inventory woes, Target will likely have to scale back its share buyback program to maintain higher dividends.
Target: Long-term investment?
The biggest question is whether 2020-2021’s high revenues and profits will continue. Will Target’s growth slow and revenues return to pre-pandemic levels? Considering consumer habits, I think this scenario is likely. Sports shoes, TVs, and treadmills are limited. Target is facing a traffic cliff because these items last longer than a few months.
Target (NYSE:TGT) partially transitioned to online retail, but Walmart and Amazon have more significant scale, competitive prices, and broader selections. Consumers will flock to general retail stores that offer low prices, convenience, and a competitive selection of goods.
Many online shoppers start at Amazon or Walmart. Target (NYSE:TGT) must improve to stay in consumers’ minds. The target must entice shoppers to buy food in its stores to generate repeat business. Target will remain a cyclical store selling mostly discretionary goods with pronounced stock swings.
Target (NYSE:TGT) improved its digital presence in the last five years, but it was too late. One-third of TGT’s sales are from private label brands, which likely have high margins. Target has been expanding its small-format store network since 2018, allowing it to enter markets where large-scale units were unfeasible. These nimble stores will likely drive Target’s future growth.
Due to the cyclical nature of its products, Target (NYSE:TGT) will likely outperform in economic upswings and underperform in downswings. The target must invest heavily to compete with its rivals, leaving little room for error. Future market performance is likely for Target.
What’s the opinion on TGT?
Inflation and changing consumer buying habits make Target (NYSE:TGT) a Hold. While the company’s dividend yield of 2.3% is higher than its peers, such as Walmart’s 1.7%, investing in dividends is not a good idea. Dividend investing requires capital preservation and future capital appreciation.
Target (NYSE:TGT) is tight because consumers buy cheaper versions of the same products and delay expensive purchases. More bad news in the next two quarters could help investors buy Target’s stock.
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