Target: Investment Thesis
Target (TGT) has performed exceptionally well so far through the COVID-19 pandemic. While first half results have been well above expectations, the bar was set very low. Taking a longer-term view, growth rates over the next few years will be below growth rates over the previous couple of years, based on current analysts’ consensus EPS estimates. A high P/E ratio compared to historical levels is a concern. Target is not an attractive “buy” at present share price levels, particularly for those concerned with capital preservation in the short to medium term. For those with a longer-term investment horizon, the company appears very solid financially with evidence of management being very much in the interests of shareholders. Buying at a lower share price would give some cushion against multiple contraction. A more comprehensive analysis and discussion follows with a further summation at end.
Below I address the following:
- The Dividend Growth Income+ Club Approach
- Reviewing Target ‘s Historical Shareholder Returns
- Checking The Target Balance Sheet And “Equity Bucket
The Dividend Growth Income+ Club Approach
The logo of the DGI+ Club explained:
Total Return, Dividends, Share Price
The only way an investor can achieve a positive return on an investment in shares is through receipt of dividends and/or an increase in the share price above the buy price – the only way.
The engines and the lubrication, along with human talent, driving the business. Shareholders have no legal rights to or ownership of the assets. Shareholders in a limited liability company have no legal obligations with respect to the liabilities.
Shareholders have an equitable entitlement to their equity in the company. Equity is increased by capital raised from shareholders and by earnings of the company. While shareholders have an equitable entitlement to their equity in the company, they have little to no say in how the equity is distributed. In some companies, management actions with respect to shareholders’ equity do not always benefit shareholders and can be highly detrimental to shareholders. At the DGI+ Club, we take the extra step of checking the “Equity Bucket” for “leaks,” i.e. effective distributions out of equity that do not benefit shareholders.
Reviewing Target’s Historical Shareholder Returns
In Table 1 below, I provide details of actual rates of return for Target shareholders investing in the company over the last five years.
Table 1 – Target: Historical Shareholder Returns
For many stocks where I create a table similar to Table 1 above, I find a wide range of returns indicating a degree of volatility and risk. Table 1 shows the results for Target were overwhelmingly positive, with double-digit returns for eight different investors, each investing $3,000 over the last five years and holding to the present. The returns range from 15.3% to 66.1%. These rates of return are not just hypothetical results. They are very real results for anyone who purchased shares on the various dates and held through to third quarter 2020. In the above examples, the assumed share sale price is the same for all investors, illustrating the impact on returns of the price at which an investor buys shares.
Assessment Based On Quant Ratings For Share Investment Decisions
Share buy price, dividends, share sale price, and duration the shares are held are the only factors affecting the return on an investment in shares. That makes potential share sale price the single most important and uncontrollable unknown when making a share buy decision. My expertise is in fundamental analysis, but I recognize any methodology, Quant or Elliott Waves or other techniques providing assistance in assessing possible future share price direction, can be of benefit to share investors.
Fig. 1 shows current SA quant rating for Target is “very bullish,” with the major contributor to this rating being “profitability.” The “growth” and “value” ratings are middle of the road and could easily tip into negative if growth is not maintained and P/E ratio were to increase as a result of any further share price increase.
Assessment Based On Analysts’ EPS Estimates
Figure 2.1 – Summary Of Analysts’ Adjusted Non-GAAP EPS Estimates at May 19, 2020
Fig. 2.1 reflects analysts’ EPS estimates per SA Premium immediately prior to release of Q1-2020 earnings on May 20, 2020. Q1-2020 actual EPS came in at $0.19 over the estimate of $0.40. Despite this the share price went down following the announcement. Q2-2020 earnings were released on Aug. 19, 2020, and EPS came in at a massive $1.73 over the estimate current at the time. Subsequently, analysts’ estimates have been upgraded as per EPS estimates in Fig. 2.2 below. The share price has also risen – significantly.
Figure 2.2 – Summary Of Analysts’ Adjusted Non-GAAP EPS Estimates at Aug. 24, 2020
Some observations on contents of Fig. 2.2 –
- The analysts’ quarterly EPS estimates for consensus, high and low, do not add to the yearly EPS estimates for consensus, high and low. This is generally the case because the analyst with the high estimate for the year is not necessarily the analyst with the highest estimate each and every quarter, ditto low and consensus figures. To overcome this, I adjust the quarterly EPS figures in the proportion of yearly totals to quarterly totals. The important takeaway here – except for the high case, these quarter/year discrepancies are minimal for 2020, indicating a reasonable degree of certainty in current EPS estimates. The estimates for 2021 show greater uncertainty, which is not surprising as estimates extend further out.
- If current estimates are uncertain, then 2023 and 2024, covered by only 2 and 1 analysts’ respectively, will be even more so. Although I will include these in my projections for completeness, I do not intend to comment on or draw conclusions in respect of these out years.
I incorporate the above analysts’ EPS estimates from SA Premium into my rate of return projections utilizing my proprietary 1View∞Scenarios Dashboards further below. As for Quant ratings, EPS and EPS growth estimates do not quantify the rate of return that can be expected for the stock in question.
Figure 3 – Non-GAAP P/E Ratios, Historical And Future Estimates
Figure 3 is primarily designed to determine an appropriate range of non-GAAP P/E ratios for determining estimated future share price levels for Target. This is necessary for quantifying estimated future rates of return. Figure 2 also informs us of past non-GAAP EPS growth rates compared to forward estimates of EPS growth based on analysts’ consensus estimates. The analysts’ EPS consensus estimates for 2020, at the time of my previous article, indicated expectations of strong negative growth rates for 2020, before recovering to 4.4% above 2019 EPS by end of 2021. The strong beat in Q2-2020 reversed that situation and gave the appearance of superlative performance for Target. But Fig. 3 shows that current estimated yearly growth for 2020, 2021 and 2022 are in fact below growth rates for 2018 and 2019. It’s possible Q2-2020 was an aberration, fulfilling pent up demand from the lock downs in Q1-2020. It should be understood, in quantifying the short-form estimated rates of return below, I’m relying on the soundness of analysts’ consensus estimates of EPS. The other important factor is determining appropriate future P/E ratios, which is fraught with difficulty. P/E ratios are impacted by issues both at the macro and micro level. I don’t believe I will have any arguments against the notion current P/E ratios are influenced by expectations of future EPS growth rates. I’m able to quantify potential rates of return under various scenarios utilizing my proprietary 1View∞Scenarios Dashboards.
Assessment Based On Quantification Of Potential Rates Of Return
My forward-looking analyses bring another dimension – the quantification of potential returns utilizing various pieces of financial information already available.
Table 2.1 – 1View∞Scenarios Dashboard Projected Rates Of Return
Table 2.1 shows buying at the current share price would provide indicative rates of return of negative (0.6)% to positive 12.3% for FY 2020 to FY 2022. These rates of return assume EPS results in accordance with analysts’ consensus, high and low estimates and a constant adjusted non-GAAP P/E ratio of 21.83 (current P/E ratio). Except for the high EPS estimates, these projected returns are well below the historical returns per Table 1. This is despite the assumed P/E ratio of 21.83 being well above the historical median and average P/E ratios of 14.42 and 15.06 per Fig. 3 above.
Table 2.2 – 1View∞Scenarios Dashboard Projected Rates Of Return – Stress Testing
Table 2.2 uses similar assumptions to Table 2.1 above, except for a reduction in the P/E ratio to 18.45, half way between the current 21.83 and the historical average of 15.06 per Fig. 3 above. Ending share price for 2020 is assumed to be 10% below the current share price (at $137.92, close to the share price immediately prior to the release of the possibly aberrant earnings result for Q2-2020). At the assumed lower P/E ratio, potential returns for 2020 and 2021 are negative for all cases, except for low single-digit return for the high case in 2021. Indicative returns for 2022 are low to mid-single digit.
Table 2.3 – 1View∞Scenarios Dashboard Projected Rates Of Return – Aiming For A Lower Buy Price
Table 2.3 projections have the same assumptions as for Table 2.2, except for an assumed buy price 10% lower than the current share price. Buying at the lower price results in positive return estimates of 3.5% through 2021 and 7% through 2022 for the consensus case, and ~10% for 2021 and 2022 for the high case. The low case offers negative return of ~4.5% per year through 2021 and through end of 2022. Buying at the lower share price improves the dividend yield on cost for all cases.
Checking The Target Balance Sheet And “Equity Bucket”
Table 3.1 Target Balance Sheet – Summary Format
Table 3.1 shows a decrease in net debt of $3,224 million over the 3.5 years, Jan. 29, 2017, through Aug. 1, 2020. This decrease in net debt was achieved through a reduction in net assets used in operations of $1,599 million and an increase of $1,625 million in shareholders’ equity. Analysis of the increase of $1,625 million in shareholders’ equity is provided below.
Table 3.2 Target Balance Sheet – Equity Section
Explanatory comments on Table 3.2 for the period January 29, 2017, to Aug. 1, 2020:
- Reported net income (non-GAAP) over the period covered shows solid growth. The non-GAAP net income excludes $302 million of income and expense items, regarded as unusual or of a non-recurring nature, in order to better show the underlying profitability of Target. These items increased GAAP EPS over the 3.5-year period by $0.54 per share compared to the reported non-GAAP result.
- Other comprehensive income includes such things as foreign exchange translation adjustments in respect to buildings, plant, and other facilities located overseas and changes in valuation of assets in the pension fund – these are not passed through net income as they fluctuate without affecting operations and can easily reverse in a following period. Nevertheless, they do impact on the value of shareholders’ equity at any point in time. For Target, these items were negative $(123) million and decreased EPS by $(0.23) over the 3.5-year period.
- Share issues to employees were not an overly significant expense item. The amounts recorded in the income statement and in shareholders’ equity, for equity awards to staff, totaled ~$676 million ($1.28 EPS effect) over the 3.5-year period. The market value of these shares is estimated to be ~$200 million higher than the amount recorded against income, which amounts to ~$(0.36) EPS effect.
- By the time we take the above-mentioned items into account, we find, over the 3.5-year period, the reported non-GAAP EPS of $20.50 ($10,804 million) has decreased slightly to $10.45 ($10,797 million) net income from operations, added to funds available for distribution to shareholders.
- Distributions – Share Repurchases – Shareholders’ Equity was reduced by $5,324 million ($10.08 per average weighted diluted share effect) for share repurchases.
- Distributions – Dividends – Shareholders’ Equity was reduced by $4,710 million ($8.90 per average weighted diluted share effect) for dividends.
- Debt metrics – Net debt as a percentage of net debt + equity has decreased from 40.1% at January 29, 2017 to 35.8% at Aug. 1, 2020, resulting in a strengthening of the balance sheet.
Summary and Conclusions
I often find with companies, while they produce earnings that increase shareholders’ equity, significant amounts of distributions out of equity do not benefit shareholders. Hence the term “leaky equity bucket.” I cannot say this has happened with Target, in fact quite the opposite. Earnings available for distribution out of equity is almost identical to reported non-GAAP earnings going into equity – no net leakage there. Distributions out of equity by way of share repurchases have been very beneficial to shareholders, with an average repurchase price of ~$80 per share over the last 3.5 years. This average share repurchase price of ~$80 compares very favorably to the current share price of $153.24. Dividend per share growth has been maintained, despite total dividend amount paid falling slightly due share repurchases reducing the number of shares on which dividends are paid. The share repurchases have contributed to the rate of EPS growth, which has in turn contributed to P/E multiples increasing from ~14.0 at beginning 2018 ~22.0 at present. Much of the high total returns per Table 1 above have been driven by multiple expansion. My 1View∞Scenarios Dashboard shows buying at the current share price could produce mid to high single digit returns, provided analysts’ consensus estimates are achieved and the P/E ratio does not fall below its current elevated level of 21.83.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor and/or a tax advisor as to the suitability of such investments for their specific situation. Neither information nor any opinion expressed in this article constitutes a solicitation, an offer, or a recommendation to buy, sell, or dispose of any investment, or to provide any investment advice or service. An opinion in this article can change at any time without notice.