A year ago I cautioned that although big-box retailer Target (NYSE:TGT) seemed to have all of the building blocks in place for a successful turnaround, the future was still unclear and therefore it wasn’t quite time to buy.
Over the past 12 months, the clouds have parted and TGT stock’s future looks pretty solid. Not only that, but the firm’s share price doesn’t reflect the promising growth on the horizon and that makes now a great time to take a position on Target stock.
Strategy Starting to Pay Off
The most important metric for retailers is comparable-store sales because strong comps suggest that the shop is holding on to existing consumers and attracting new customers.
For Target, same-store sales have been impressive for five consecutive quarters. In the most recent quarter comps were up 5% at Target with physical locations seeing 3.2% growth in same-store sales and digital sales up 36%.
Target has struggled to keep up with peers like Walmart (NYSE:WMT) when it comes to building out an online presence, because the firm simply doesn’t have the same size and reach that the discount superstore does. However, the firm has been focusing on productivity and efficiency and that strategy is starting to bear fruit.
CEO Brian Cornell has focused on creating an omni-channel shopping experience that doesn’t grow online sales at the expense of store traffic; that approach appears to be working. Target uses its existing locations as fulfillment centers which has allowed the firm to grow its Target.com business without jeopardizing sales at physical locations.
Things aren’t all rosy for Target stock. The company took a hit on profitability in order to invest in its turnaround strategy. Gross margins in Q4 fell considerably from where they were a year earlier- but that’s to be expected when you’re building out an online presence. However, a temporary weakness in profitability in order to pave the way for long-term growth is a price worth paying.
Another concern for investors has been Target’s grocery business, which has struggled to compete against both Walmart and Amazon (NASDAQ:AMZN).
Admittedly, the future of Target’s grocery business is still murky. However, based on the company’s success shifting its online strategy, I have faith that CEO Brian Cornell will implement a similarly air-tight plan to lift Target’s grocery business in the years to come.
Valuation and Target Stock
One of the biggest reasons TGT stock should be on your watch list is the fact that the company isn’t priced for a successful turnaround. At $76 per share the company’s P/E ratio is significantly lower than the market average.
Target trades at just 13 times its forward earnings, well below the S&P BMI consumer discretionary average of 20.65 times. Plus, Target offers a 3.3% dividend yield, which is above average for the sector.
The Perfect Storm
Target stock is in a sweet spot right now. The firm’s turnaround looks to have firmly taken hold and although there are still obstacles to clear, the current environment is ideal for a retailer to pull off a strategy shift. However, the market isn’t quite convinced yet and so TGT isn’t priced to make a comeback.
This is likely to be a strong year for Target, especially if its online business continues to turn in digital sales growth of 25% and higher.
Investors are unlikely to cheer Target stock until profitability picks up significantly, but the most recent quarterly results suggested that the worst is over. Operating profits in the fourth quarter declined, but only because the previous year included an extra sales week. When you take away that advantage, margins were steady. In 2019, management foresees a modest increase in profits.
The Bottom Line on Target Stock
Target is ready to make a full fledged comeback and investors haven’t jumped on the bandwagon just yet. Of course, there are still some kinks to be ironed out, but I’d say TGT is looking like a pretty good bet for 2019.
As of this writing Laura Hoy was long AMZN.
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