Target (NYSE:TGT) is in the middle of a rebound year. It was up 21% in just-ended first quarter, against the S&P 500 index‘s 14.5% rise. Keep in mind that TGT stock averaged an annual total return of -1% over the past four years.
If you were courageous enough to buy Target stock last December when it was trading in the low $60s, you’ve done well for yourself. But, if you’re thinking about taking profits, here’s why that’s a bad idea.
Reversion to the Mean
If you go back to January 2000 when Dayton-Hudson changed its name to Target to reflect the fact that the company got more than 75% of its annual revenue and pre-tax profit from its discount retailer, TGT stock’s generated an annual total return of 7.1%.
While that doesn’t seem like much, the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) averaged 6.1% over the same period.
When you consider that Target’s spent the last four years in neutral, TGT stock’s nice move so far this year is a reflection of all the hard work CEO Brian Cornell his team have done since his arrival in July 2014.
However, you could also argue that after four dud years, Target stock is merely reverting to the mean.
Where to Next?
Before hitting $100, Target stock must first get back to its 52-week high of $90.39, which it hit in September last year.
What’s behind Target stock’s fall from $90 to $60 in three months?
For the answer, I go to Vince Martin, my InvestorPlace colleague, who wrote a piece in late January why Target stock didn’t look cheap enough — it was trading around $72 at the time, 20% off its December low.
“While Target’s sales growth seems impressive, it should be impressive. It is, after all, a retailer in the tenth year of an economic expansion,” Martin wrote on January 30. “Target’s performance ought to be good right now because it’s not going to be great when the macrocycle eventually turns. So if Target can’t grow its earnings in this environment, when will it be able to do so?”
However, that doesn’t take into account the fact that Cornell took over a business that lacked identity and was failing miserably with its Canadian expansion. Before the CEO could right the ship and create a strategy for growth, he first had to make some tough choices, including putting Target Canada into bankruptcy protection. It subsequently closed all 133 stores.
That takes time.
Fast Forward to Today
Several of my other InvestorPlace colleagues see Target in a slightly better light. As do I.
In mid March, I argued that the CEO’s move to get all of the stores acting as fulfillment centers was stolen right out of the Best Buy (NYSE:BBY) playbook. I didn’t mean that it a bad way. Best Buy’s stock is trading well off its five-year lows in the mid-$20s precisely because it fully utilized its real estate footprint.
Good executives aren’t too proud to borrow good ideas. The last time I looked, Target also had a pretty big real estate footprint.
On March 13, I wrote that “not everything’s perfect about Target’s business.” “It continues to struggle with its grocery store business. It’s not so much that it isn’t growing sales — its food and beverage business has increased for six consecutive quarters — but it doesn’t have a coordinated strategy to take its grocery game to the next level.”.
My feeling then was that Cornell and team are on top of the situation. “In 2-3 years, investors won’t recognize the company’s grocery business.”
Sure, it’s possible that the grocery business doesn’t take hold. However, if you bought in the low $60s, I’d stick around to find out because if the CEO nails this, $100 won’t be an issue.
Bottom Line on Target Stock
InvestorPlace contributor Laura Hoy recently expressed concern about the company’s shrinking gross margins in the fourth quarter. While that’s something worth watching, the gross margin for the entire year was 28.8%, only 100-200 basis points off its historical average.
Farther down the P&L, its operating margin was 5.8%. Also, 100-200 bps off its norm.
However, if you consider the return on invested capital in 2018, it’s doing well, historically speaking. In 2018, its adjusted ROIC was 14.6%, 100 bps higher than in 2017. If you go back over the past decade, Target’s ROIC has rarely, if ever, been as high.
I look at the glass being half full for TGT stock investors.
The company continues to grow digital sales. Up 36% in 2018, they still only account for 7.1% of its overall revenues. In five years, that number will be in double digits, perhaps even as high as 20% if Shipt, its same-day delivery service continues to gain market share.
I think $100 a share for Target stock could be right around the corner. If you bought in the low $60s, I’d hang on for the ride.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
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