After Earnings, Is Target Stock a Buy, a Sell, or Fairly Valued?

Target TGT released its second-quarter earnings report on Aug. 21. Here’s Morningstar’s take on Target’s earnings and stock.

Key Morningstar Metrics for Target

• Fair Value Estimate: $136.00
• Morningstar Rating: 2 stars
• Morningstar Economic Moat Rating: None
• Morningstar Uncertainty Rating: Medium

What We Thought of Target’s Q2 Earnings

• At first glance, Target’s comparable sales growth of 2% (in line with our forecast and led by a 3% gain in traffic) looked solid, though we note the firm was lapping an abysmal 5.4% decline from the prior year. The company’s growth trajectory also lagged that of Walmart WMT, which saw its Walmart US segment deliver 4.2% comp growth in the quarter.
• Competitive intensity seems to be picking up in the retail industry, as firms appear to be aggressively competing for foot traffic. Target’s management team noted that consumers are seeking value, and it reduced prices on 5,000 frequently purchased items during the quarter to attract shoppers.
• Operating margin expanded 160 basis points to 6.4% (ahead of our 5.4% estimate) as cost efficiencies and lower shrink more than offset increased markdowns. In the longer term, we think Target will struggle to deliver pronounced margin expansion due to intense competition from lower-priced brick-and-mortar peers (such as Walmart and Costco Wholesale COST) and online retailers.
• We do not plan to materially alter our fair value estimate of $136 per share for Target, as our long-term outlook remains intact.

Fair Value Estimate for Target

With its 3-star rating, we believe Target’s stock is fairly valued compared with our long-term fair value estimate of $136 per share. The company’s top line landed mostly in line with our expectations in the last quarter, as comparable sales fell 3.7% (versus our estimate for a 4% drop) amid a drop in traffic and the average ticket. Management cited ongoing weakness in discretionary categories and noted that frequency categories (such as food and household essentials) suffered slight declines during the quarter.

While we expect the retailer’s sales to recover in coming quarters as it laps easier comps, we think the firm’s lackluster top line indicates its precarious value proposition. On a positive note, Target’s operating margin (up 10 basis points annually to 5.3%) was buoyed by a 140-basis-point lift in gross margin, though we think profits will remain pressured as the firm resorts to more aggressive price reductions to increase store traffic. Our fair value estimate implies a forward fiscal 2024 adjusted P/E of 15.0 times and enterprise value/adjusted EBITDA of 8.3 times.

Read more about Target’s fair value estimate.

Economic Moat Rating

We do not believe Target warrants an economic moat. Despite its iconic and trendy brand, we view Target’s position in the hypercompetitive retail environment as rather ambiguous, which dilutes our confidence in the durability of its brand to drive consistent store traffic. Furthermore, we don’t see sufficient evidence to award Target a cost advantage. Although it is the nation’s sixth-largest retailer, we do not believe the firm exhibits unreplicable scale across its individual product categories that would suggest it has amassed negotiating prowess over its supplier partners.

While Target is seemingly ubiquitous among American consumers, we do not believe its business model offers significant differentiation from other retailers that would warrant a durable brand advantage. Cognizant of its size relative to its fellow superstore competitor (the firm’s $106 billion in 2023 sales are about one-fourth of Walmart’s US sales), Target doesn’t attempt to be the nation’s lowest-priced retailer and instead emphasizes offering an impeccable shopping experience. Stores are clean, well-lit, adequately staffed, and full of seemingly trendy product offerings—elements of the customer experience we view as replicable.

Read more about Target’s economic moat.

Financial Strength

After three years in which it saw its top line balloon by nearly 40%, Target finds itself in a strong financial position with a conservative debt ratio (net debt/2023 EBITDA stood at 1.2 times) and ample liquidity. At the end of its 2023 fiscal year, the retailer had about $14 billion in debt and held $3.8 billion in cash (plus $4 billion in an untapped revolving facility). This is consistent with its past mantra, as the company has prioritized operating with a strong balance sheet for more than two decades (net debt/EBITDA has averaged 1.6 times since 2000).

Target’s debt maturities do not appear particularly burdensome, as two-thirds of outstanding debt doesn’t come due until 2028 or later, and nearly one-third is due after 2032. Furthermore, the retailer owns nearly 80% of its stores and land (87% including owned buildings on leased land). We think Target’s vast underlying real estate portfolio may allow the firm to seamlessly raise capital at cheap rates via a sales leaseback or by collateralizing debt with its owned properties in the future.

Read more about Target’s financial strength.

Risk and Uncertainty

We assign Target a Medium Morningstar Uncertainty Rating. The rise of digital penetration serves as a formidable threat to Target’s traditional brick-and-mortar retail model. Price shopping has become rather seamless as consumers increasingly begin their product searches via digital channels, making Target susceptible to price competition amid an industry where consumers face virtually no switching costs. The retail industry’s preemptive leaders—Walmart and Amazon.com—boast unrivaled scale and an impressive ability to invest in supply chain automation to mitigate costs. We expect Walmart and Amazon to serve as disinflationary forces in the industry for years to come, putting pressure on retailers that lack a differentiated product offering, vast scale, or a concentrated geographic focus (we believe Target falls into all three categories). As such, we think that gross margins may be pressured over the following decade.

Read more about Target’s risk and uncertainty.

TGT Bulls Say

• Given its iconic brand that attracts consumers with its promise of a more gratifying customer experience compared with other low-cost retailers, we are confident in Target’s ability to drive recurring foot traffic.
• Based on its performance during the pandemic, we view Target as a formidable online retailer, putting to rest many concerns about its ability to compete in a digital retail environment.
• Target is poised to benefit from the continued decline of mall-based competition and department stores, which will drive strong growth in comparable sales.

TGT Bears Say

• Target lacks the scale and differentiation to drive significant market share across its product categories, since its product offerings lack a clear value proposition.
• Despite being the nation’s sixth-largest retailer, Target must constantly invest in cost-saving initiatives, product innovation, and store renovations just to keep up with behemoths Walmart and Amazon.
• Target’s higher-margin discretionary product categories, such as apparel and home furnishings, are susceptible to losing market share via digital retail penetration, which could weaken the firm’s margins.

This article was compiled by Leona Murray.