Target (NYSE: TGT) has drawn attention in recent weeks for its critical missteps. The company reeled following a huge earnings miss and has suffered further as its excess-inventory issues come to light.
But despite all of its travails, Target remains a strongly positioned company from a business and financial standpoint, and the current multiple could offer prospective buyers a unique opportunity to add shares.
Target’s struggles and attributes
Admittedly, Target seems like the last retailer investors might want right now. The company overbought inventory due to supply-chain concerns. At the close of its fiscal first quarter 2022 (ended April 30), Target reported $15.1 billion in inventory, well above the $10.5 billion in the year-ago quarter.
This oversupply has compelled Target to sell much of its inventory at a significant discount as Q1 gross margins fell to 26%, well below the 30% level of a year ago. Given such conditions, one might understand why the stock fell by, at one point, almost 40% in less than two months.
Still, Target has successfully retained its customer loyalty with a track record of responding quickly to rapidly changing consumer needs. To compete with Amazon, Target instituted same-day delivery and curbside pickup as part of an omnichannel strategy, which combines online and in-store selling. This helped it not only survive but also perform well during the pandemic in 2020. Today, omnichannel accounts for around 18% of company sales.
Moreover, categories such as household essentials and beauty continue to lead Target’s sales. It rolled out an Ulta Beauty at Target last August, a store within a store that operates in some locations. Target plans to roll out this concept at 250 additional stores, meaning Ulta will have a presence in about 800 locations.
How the challenges affected the financials
Despite these headwinds, Target’s comparable-store sales have continued to increase, rising 3% year over year in the first quarter of 2022. And the company reported $25.2 billion in revenue, a 4% increase from the same quarter last year.
Its pain came from net earnings, which fell by 52% during that time frame to about $1 billion. A 10% surge in the cost of sales and a 6% increase in selling, general, and administrative expenses weighed on the bottom line. Additionally, a 76% year-over-year increase in property and equipment spending left the company with $442 million in free cash flow, barely enough to cover the $424 million in dividend expenses.
Still, Target’s dividend has now increased for 51 straight years, giving the company Dividend King status. And thanks to the increase announced on June 9, that dividend now amounts to $4.32 per share annually. This results in a cash yield of more than 2.7%, well above the S&P 500 average of about 1.5%. The previous annual dividend was $3.60 per share, meaning shareholders received a 20% increase.
Moreover, Target can afford this payout hike because it generated more than $5 billion in free cash flow in 2021, allowing it to cover $1.5 billion in dividend costs. Target also plans to continue share repurchases, but with cash levels falling to just $1.1 billion (from $7.8 billion in the year-ago quarter), they will probably occur at a slower pace than the $7 billion the company bought in 2021.
Furthermore, Target has generally outperformed the S&P 500, logging a total return (which includes dividends) of more than 225% over five years, a performance that outpaced its largest peers, including Amazon. Also, the recent drop took its P/E ratio to just 13, well below Walmart at 26 times earnings and Costco at 37. Such a multiple indicates sellers might have overreacted to what will probably be a temporary challenge, and that discounted valuation could persuade many investors to buy the dip.
Making sense of Target stock
Amid the current conditions, investors in this retail stock might want to consider adding shares. Indeed, its overbuying will mean a hit to its profitability, and both price and labor inflation will weigh on profitability in the near term.
Nonetheless, Target still manages to generate enough free cash flow to pay its dividend, and rising comparable-store sales show that consumers continue to shop at Target. With its P/E ratio well below those of its peers, the opportunity to buy Target stock this cheaply might not last for long.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Will Healy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Costco Wholesale, Target, and Ulta Beauty. The Motley Fool has a disclosure policy.