Best of the Big-Box Retailers

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

Retail stocks can be some of the most attractive investments for a few reasons.  For one, most people have heard the phrase “Invest in what you know.”  What do you know better than a company whose stores you shop in, whose clothes you wear, or who sold you the computer you’re using to read this.  In addition, retail stocks can be stable, relatively predictable, investments if you choose wisely.  Finally, retail can be a great way to simultaneously expose your portfolio to both solid, rising dividends and growth opportunity.

The type of retail stock best suited to long-term investing are large, diversified retail stores.  Of these, the “big three” are Wal-Mart (NYSE: WMT), Costco (NASDAQ: COST) and Target (NYSE: TGT).  A good case can be made for any of these three, and they are all solid long term investments with plenty of reasons to like them.  My personal favorite is Target, based on the dividend yield, growth strategies, and valuation. 

Target operates 1,525 Target locations, 251 Super-Target stores, and 5 CityTarget stores.  Unlike Wal-Mart and Costco, Target stores generally cater to middle- and upper-income consumers.  Super-Targets carry the same full line of products, and in addition have a full grocery store.  CityTargets are smaller and are found in urban markets. 

Target grows primarily through both new store openings and rising same-store sales.  Target has expanded relatively aggressively over the past five years, opening 275 new stores during that time period.  In FY 2013 (which ends January 31, 2013), Target plans to add 15-20 new stores and remodel 230 existing stores.  In regards to the remodeling, Target is introducing its PFresh store layout in existing stores, in order to incorporate fresh foods, which lead to more frequent visits by customers. 

One of the best drivers of growth for Target over the next few years will be its entry into the Canadian market.  The company expects to open 125-135 Canadian stores, beginning in calendar year 2013, and this is expected to reduce FY ‘13’s EPS by $0.50.  In addition, in October, Target agreed to sell its credit card business to TD Bank Group, which happens to be based in Canada, for approximately $5.9 billion (or the value of credit card receivables at the time the transaction closes).  Target will continue to earn a portion of the profits generated by the cards, and the company intends to use 90% of the share proceeds to reduce its debt, which as of the end of FY ’12 was $13.7 billion, so this should put a significant dent in Target’s long-term debt.  The company plans to use the remainder of the proceeds for share buybacks.

Target is also a decent dividend payer, yielding 2.42% annually.  The company has a great track record of raising the dividend, and in fact, they have done so consistently for the past decade, from $0.24 per share in 2003, all the way up to $1.44 annually today.  This is an average increase of 22% per year, sustained over a 10-year period!  Very few companies achieve not only these types of increases, but this level of consistency.

Now, in terms of valuation, Target is, in my opinion, the cheapest of the “big three.”  Currently, Target trades at only 13.4 times TTM earnings, as opposed to 14.1 for Wal-Mart and 22.1 for Costco.  This is a very favorable valuation for a company that is expected to grow its earnings at an annual rate of 12% for the next three years, according to Standard and Poors, a higher rate than is expected for Wal-Mart and the same as Costco.  Target is expected to earn $5.00 per share for FY 2014 (ending in January 2014), so based on current pricing, Target is trading at only 11.9 times forward earnings.  Assuming the multiple stays the same as now (13.4), this gives us a one-year target (no pun intended) of $67.00.  However, the average P/E multiple for the overall big-box retailers sector is 14.6 times earnings, giving a target of $73, which is 22.4% above current levels.

 

 


KWMatt82 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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