A Higher Price for Target Stock May Be Elusive

Stocks to sell

Not all businesses in the U.S. were hurt by the Covid-19 pandemic lockdowns. In fact, many companies produced some of their best financial results ever in 2020. Retailers that had a strong omni-channel presence did quite well, including Target (NYSE:TGT). And TGT stock benefitted as well.

an image of bullseye the target (TGT) dog in a target store

Source: Robert Gregory Griffeth / Shutterstock.com

This 100-year-old retailer grew comp sales 19.3% in 2020, which is an astonishing figure considering this mature company has 1,897 stores and limited unit growth due to the continued rapid increase of online shopping. The previous two years of annual comp growth were at 3.4% and 5%. In 2020, Target added $15 billion in sales, more than the previous 11 years combined.

Will the Double-Digit Growth Continue?

Apparently, some investors believe it will, as TGT stock trades at a ridiculous 24 times forward price-to-earnings (P/E) ratio. Target’s historical P/E has been in the low double-digit range in recent decades, as many mature retailers find organic growth hard to come by. In addition, the retail industry is notoriously cyclical and does not perform well in recessions. Therefore, it rarely commands high valuation multiples. Comp sales for Target declined in both 2009 and 2008.

In fairness, no reasonable person thinks this year will be a growth year for Target. Those 2020 comp sales make it almost impossible to repeat. Consensus revenue estimates call for a decline in revenues this year to the tune of about -2%. The lowest estimate I could find expects revenues to decline 6% to 7%.

Part of the success in 2020 was due to a strong omni-channel presence, meaning customers could choose between online purchase and delivery, online purchase and pick-up in store, or the traditional method of grabbing a shopping cart and walking around one of their massive 170,000 square-foot stores.

Last year, 12 million customers became multi-channel customers using more than one of those three methods. According to the company, multi-channel customers spend four times more than a physical-store-only shopper and 10 times more than a digital-only shopper. This bodes well for Target’s future, as the pace of building those large super-center stores will likely slow down significantly.

Owned Brands

One of Targets great success stories has been the development of its own brands. These include such brand names as Archer Farms, Cat & Jack, Simply Balanced and Market Pantry. The company owns 48 different private-label brands, which now represent about a third of total sales.

This strength in owned brands helps maintain or enhance overall margins and may offset some of the continuous long-term pricing pressure from competitors such as Amazon (NASDAQ:AMZN) and Walmart (NYSE:WMT).

TGT Stock Trades at Too-High Valuations

As previously mentioned, TGT stock currently trades at 24 times 2021 estimated EPS. Let me say that again to ensure everyone that wasn’t a typo — a P/E of 24. In recent years, we’ve witnessed outrageous valuations for many tech and growth stocks, with the justification that they can grow 50% a year into perpetuity because their products are so innovative and disruptive. (They won’t, of course.)

But how does one justify these valuations for a large retail industry player that will likely grow at GDP rates plus a few points if they execute very well? Target’s online business can grow at strong double-digit rates for quite some time, but at some point their physical stores are at risk of being stranded assets.

To be fair, 2021 is a down year due to difficult comps against 2020, so the P/E ratio for 2022 drops to about 21 times. This compares to 20-year historical P/E averages that range in the low to mid-teens. And the company isn’t giving guidance this year,

“… in light of the highly fluid and uncertain outlook for consumer shopping patterns and the impact of Covid-19.”

Reading between the lines, this means there’s no chance at all they will even come close to duplicating the fantastic results from 2020.

Do Share Buybacks Make Sense?

Even more disturbing is the company’s statement that at the end of FY 2020, there was $4.5 billion available on their share repurchase program. Buying back shares at extraordinarily high valuations with the stock price near all-time highs is a surefire way to destroy shareholder value and waste the companies own capital.

From one finance geek to another (the TGT CFO) — save your money and wait for that fat pitch to buy your own stock. And then maybe that P/E will be justified at some point.

Investors should also wait for that fat pitch and avoid the stock at these levels.

On the date of publication Tom Kerr did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Kerr, CFA is an experienced investment manager and business writer who has worked in the investment and securities business since 1994.