Just Buy This Retailer

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Headquartered in Minnesota, Target Corporation (NYSE: TGT), is the second largest discount retailer in the United States. As of March 4, 2013, Target had 1,778 stores in the United States. Apart from its stores, Target also sells its general merchandise through its website—Target.com.

Quarterly Earnings

Recently, Target announced its earnings for the fourth quarter of 2012. Target reported earnings of $961 million, or $1.47 a share, down from $981 million, or $1.45 per share, a year earlier. The retailer missed its earnings estimates as the number of purchases was down 1%. Gross margin decreased to 27.8% from 28.4% last year.

Food and other basic items did really well, but the gift items didn’t show a lot of promise, especially in the holiday season. It was the worst holiday season for the company since 2008. More customers used their credit / debit cards, which allow a 5% discount to loyal customers. About 15.5% of store purchases were paid through cards, which grew 4.7% from the same quarter last year. Moreover, the discounts offered during the holiday season put a downward pressure on company’s margins.

Going Forward

Target has plans of testing its new programs, like letting its customers pay online and collect in-store, delivering items on the same day, and catering to shoppers using mobile phones. Also, the company is about to give its credit card portfolio to Toronto Dominion Bank and will be opening 124 stores in Canada. For the year, Target is expecting its revenues to increase by 2% versus a growth of 5.1% in 2012. Sales at stores open at least a year are estimated to grow by 2.7%.

In this quarter, analysts expect Target to earn $1.02 per share on revenues of $17.07 billion. For the full year, analysts’ estimates stand at $4.71 a share on revenues of $75.70 billion.

Valuation

Target is trading at a forward P/E (1yr) of 12.03x and has a PEG of 1.23. Incorporating a dividend yield of 2.20% into its PEG gives us a healthy PEGY of 1.04. Using an industry forward P/E of 15.06x, I would value Target as follows:

<img src="/media/images/user_15296/target5_large.PNG" />

Using consensus estimates for the current year, Target’s value comes out to be $71, showing an upside potential of almost 8%. Adding a dividend yield of 2.20% gives a total return of more than 10%. 

Competitors

The United States’ biggest retailer and the world’s third largest public corporation, Wal-Mart (NYSE: WMT), is trading at a forward P/E (1yr) of 12.58 and has a PEG of 1.56. It’s yielding 2.60% on its dividend and has a PEGY of 1.22. Using earnings estimates, I value Wal-Mart at $80. Therefore, it’s undervalued by almost 9% and appears to be one of the best buys in the retail sector. You can have a further look at my detailed take on Wal-Mart here.

On the other hand, Costco Wholesale Corporation (NASDAQ: COST) is trading at a forward P/E (1yr) of 20.56, which makes it one of the most expensive buys in the industry. It has a dividend yield of 1.10% and a PEG of 1.73. A growth rate of 14.5% testifies to the fact that the company is expected to do well in the coming years. A mean recommendation of 2.1 on the sell side suggests that it’s also one of the best buys in the industry.

Conclusion

Given the fact that the U.S. economy is still recovering at a snail’s pace, margins for the U.S. retailers are likely to remain low, at least until the end of 2013.  Furthermore, with the looming risk of another economic recession, shoppers are expected to refrain from excessive spending. As a result, Target isn’t expecting a lot from the U.S. market this year.

Target’s biggest catalyst this year will be its operations in Canada, where the company expects higher margins. According to the company, the majority of its 124 stores there will be opened this year, giving its margins a significant impetus. This in turn would drive its earnings up in 2013. In short, I recommend buying Target for an upside of at least 8%.


Vamosrafa7 has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of 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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