Wednesday, September 14, 2011

At a Lower Price, Target Should Be in Your Sites

Target (NYSE: TGT) suffered an outage of its web site on Tuesday. The bad news was a result of too much demand and not enough supply as consumers were desperate to get their hands on the latest product innovation from Target. Is that enough of a reason to buy its stock?

Italian luxury knitwear designer Missoni sells consumer goods for very high prices -- as much as $1,500. But Tuesday it launched a 400-piece line of Missoni for Target -- a collection of bikes, luggage, clothes and housewares. This so-called "cheap chic retailer" featured Target's zigzag patterns for between $2.99 for stationary and $599.99 for patio furniture — far less than Missoni's real products that range in price between $595 and $1,500.

Target understands something essential about its customers -- they aspire to own elite brands but can't afford them. The celebrity-industrial-complex creates a deep popular hunger for what consumer can't attain. And then Target lowers the drawbridge and lets them in through these specialty sales. Even if it does not make money on these items, it does bring in many new customers who may buy other -- higher margin goods.

But is Target's success with Missoni reason enough to buy its stock?
  • Great earnings reports. Target has been able meet or beat analysts' expectations in all of its past five earnings reports.
  • Higher sales and profits and decent balance sheet. Target sales have grown at a 4.4% annual rate over the last five years from $58.5 billion (2007) to $69.5 billion (2011) and its net income rose slightly at a 0.9% annual rate from $2.8 billion (2007) to $2.9 billion (2011). Its debt has risen -- but its cash is up more. Specifically, its long term debt rose at a 15.7% annual rate from $8.7 billion (2007) to $15.6 billion (2011) while its cash climbed at a 20.3% annual rate from $813 million (2007) to $1.7 billion (2011).
  • Out-earning its cost of capital and getting better. Target is earning more than its cost of capital – and it’s improving. How so? It’s producing positive EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In 2011, Target 's EVA momentum was 1%, based on 2010 revenue of $65.4 billion, and EVA that improved from 2010's $2 billion to 2011's $2.4 billion, using a 7% weighted average cost of capital.
One negative:
  • Extremely high valuation. Target trades at a Price-Earnings-to-Growth ratio of 8.29 -- 1.0 is fair value – a forward P/E of 23.2 on earnings forecast to grow 2.8% to $4.33 in fiscal 2013.
For all Target's great stores, clever marketing, and solid financial performance, the stock price is way ahead of Target's earnings growth rate. Unless its price tumbles or its earnings growth spikes, Target stock is no value.


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