Don’t Overlook This Highly Undervalued Dividend Stock

Anjali is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The shares of Target (NYSE: TGT), the second largest retailer in the US, have outperformed the broader markets this year and have gained more than 19% as compared to S&P500’s 13% year to date gain. Despite the recent gain, I think Target is still highly undervalued. Rather than realizing the long term growth potential, the market seems to be focusing on the short term challenges faced by the company. However, the street estimates for the next 5 year annual growth rate clearly reflect Target’s long-term cross-selling opportunities. Let’s compare the valuation, growth rate and dividend yield of Target with its peers including Wal-Mart Stores (NYSE: WMT) and Costco Wholesale (NASDAQ: COST).

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Target</p> </td> <td> <p>Wal-Mart</p> </td> <td> <p>Costco</p> </td> </tr> <tr> <td> <p>Forward PE</p> </td> <td> <p>12.53</p> </td> <td> <p>13.99</p> </td> <td> <p>19.74</p> </td> </tr> <tr> <td> <p>Dividend Yield</p> </td> <td> <p>2.30%</p> </td> <td> <p>2.10%</p> </td> <td> <p>1.10%</p> </td> </tr> <tr> <td> <p>This Year Growth</p> </td> <td> <p>2.60%</p> </td> <td> <p>9.40%</p> </td> <td> <p>12.30%</p> </td> </tr> <tr> <td> <p>Next Year Growth</p> </td> <td> <p>11.60%</p> </td> <td> <p>8.80%</p> </td> <td> <p>11.70%</p> </td> </tr> <tr> <td> <p>Next 5 Year Growth</p> </td> <td> <p>12.13%</p> </td> <td> <p>8.30%</p> </td> <td> <p>12.88%</p> </td> </tr> </tbody> </table>

From the above table, we can clearly see that Target’s one year and five year expected graowth rates are far better than Wal-Mart's and mostly in-line with Costco's, yet it is trading at more than a 10% discount to Wal-Mart and 36% discount to Costco. Target has been aggressively (at an average of 24.57% per annum) raising its dividend over the last five years and currently yields 2.30% which is better than Wal-Mart and more than twice that of Costco. Moreover, the company has expressed its intention to raise the dividend to $3.00 per share (from $1.40 today) by 2017.

Instead of focusing on these long term parameters, the market seems to be focused on near-term results; hence, Target is trading at a discount to its peers. Target’s current year’s growth looks disappointing at first, but it is hampered by the capital investments which will ultimately drive stronger results in the coming years. Expansion in Canada will be dilutive to EPS this year, but it represents a strong long term growth opportunity. Target is on track to open at least 125 Canadian stores in a rapid expansion taking less than two years and once the company establishes itself in Canada, profits are bound to come.  As a matter of fact, Target anticipates generating $6 billion in sales and $0.80 in EPS (10% of consolidated EPS) by 2017.

The company is also taking various efforts to improve its shopping experience for customers. Recently, Target launched an entire new website, www.Target.com/TopToys, dedicated to easily locating and purchasing toys. The site will feature 10,000 items and the consumer will have the option to browse by age, gender, brand, or character, in order to find the perfect gift. In addition, Target is also aiming to drive sales during the holiday season with special promotions and sale prices. Target’s annual toy catalog will include coupons for the financially-conscious consumer, and Target REDcard members will save an additional five percent regardless of whether they purchase online, in a store, or through the catalog.

Exposure to higher income consumers and more discretionary parts of retail such as apparel and home (39% of sales) represent attractive leverage points to a recovery in discretionary spending. With P-Fresh and 5%-off rewards initiatives driving traffic, I believe Target is well positioned to monetize any improvement in its guests’ discretionary spending patterns.

To conclude, I think Target remains a top long-term idea due to attractive valuation, accelerating dividend yield, powerful top-line drivers (PFresh/5%-off), and prospects for accelerated EPS growth in FY13/FY14 as Canadian headwinds moderate and operations turn profitable. Hence, I recommend buying this stock.


AnjaliPaliwal has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale. Motley Fool newsletter services recommend Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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