Target: A Good Retirement Stock with Near-Term Upside

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

Shares of Target (NYSE: TGT) are up today and trading at 52-week high, after the retail giant reported 2Q results yesterday. The company has been successful in beating the consensus estimates for the fifth consecutive quarter and 2Q12 EPS of $1.06 was significantly above the consensus estimates of $1.01. The company also reported good same-store sales growth of 3.1%. We believe the stock is likely to see a near-term upside and should also be a good addition to the retirement portfolio given its accelerating dividend yield and favorable business economics.

Encouraging start to 3Q

We believe Target has solid momentum and is well-positioned heading into the important Back to School selling season. With 3Q Same Store Sales guidance of 3% meeting consensus expectations and quarter-to-date sales running in-line with this guidance, we believe that investors will continue to reward Target shares near term for delivering consistent sales against an uneven economic and competitive environment.

Canada Expansion: Near-term issue but a long-term growth opportunity

Though, Canadian expansion is expected to be dilutive to FY12 EPS and FY13 EPS. But the negative impact on FY13 EPS will be significantly less as compared to FY12 as stores begin to operate and we believe the Canada Business will start turning to a profit by the end of next year. We believe TGT is being double penalized (depressed valuation and EPS dilution) as investors have near-sightedly focused on near-term earnings. We continue to believe Canada represents a long-term growth opportunity for Target and expect multiple expansion as Canada turns on and Target clicks into mid-teens EPS growth rate.

Favorable Business Economics

Target’s brand-logo is recognized by 96% of its customers and the company has strong economic fundamentals with consistent free cash flow generation. While apparel retailers like Abercrombie & Fitch (NYSE: ANF) and Aeropostale (NYSE: ARO) are struggling with rising inventory, Target’s less dependence on apparel/accessory segment (less than 20% of total sales) makes it immune to growing pressure of inventory management. Moreover, grocery segment which derives more than 40% of total sales provides a low-cost alternative to premium grocers and is thus expected to remain stable even in a difficult macro environment.

Accelerating Dividend Yield

The following chart summarizes the dividend yield and dividend growth comparisons of Target and Wal-Mart (NYSE: WMT).


<img src="/media/images/user_12976/tgt1_large.png" />

Over the last 5 years, Target hiked its dividends at a much higher average rate than Wal-Mart. As a result, Target currently yields slightly more than Wal-Mart. If both the companies maintained their dividend growth rates, Target would have a significantly higher yield on cost in the long-term. Though a long term 20+ dividend growth rate may not be sustainable, still let’s say even if the company is able to continue a 20% dividend growth rate for the next 4-5 years, the stock would have a 4.5-5% yield on cost. We believe the average dividend growth rate for the next 5 years will be consistent with the average dividend growth rate over the last 5 years as the management has expressed its intention to raise the dividend to $3.0 per share by 2017.

Target is trading at a forward P/E of 13.24 and we believe there is room for expansion. Other positives include company’s discount chain model and vast online presence. Given current momentum, accelerating dividend yield and opportunities in Canada, we remain bullish on this stock. Thus, we recommend it a good buy.

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