Finanzas: Why Target Is Not A Suitable DGI Position
- Target is at 52-week lows, but that doesn’t automatically make it a buy.
- Yes, the company provides a strong current yield.
- But without growth, this company is likely to disappoint longer-term investors.
- Target hasn’t proven that it’s a “wonderful” company in recent years.
Shares of Target (TGT) have declined sharply over the past three months, falling from the high 70s to 55 today.
This has led to a contentious debate over TGT stock. While I’ve always been preferential to Wal-Mart (WMT) over Target, I’ll admit the choice isn’t quite so clear-cut anymore. The market is finally giving Wal-Mart a premium valuation compared to Target.
With Target now bruised and on the clearance rack, is it finally a buy? For short-term traders or very income-focused investors, there’s a case to be made. But it’s my contention that this still is a poor choice for dividend growth investors, even at the admittedly more attractive price.
DGI: Don’t Forget The Growth
For investors focused on rising dividend streams, one has to look at the competitive position of a business. The magic of DGI is that such companies continue to dominate their market positions over the years, allowing them to raise prices consistently and maintain their market share.
One of the pitfalls with DGI style buy-and-hold portfolios can be that companies lose their competitive edge. A company like Eastman Kodak (NYSE:KODK) is a classic example; it dominated a key market segment for decades. Then, technological innovation came along and management had to react.
As early as 1975, Kodak had developed a digital camera, but abandoned plans to do more with the technology in order to protect their heritage in the analog market. In the 1990s, Kodak planned its transition to digital, but signs were clear that management wasn’t fully cognizant of the coming magnitude of the change.
Despite the clear signs that the analog film business was heading for obsolescence, Kodak’s profits didn’t peak and really start declining until the year 2000. The dividend would in fact be hiked as late as 2002, well after it was clear that Kodak’s future was far dimmer than its past. Investors buying based on a record of past dividend hikes missed seeing a train wreck as it was occurring.
Kodak was a classic DGI stock for decades. It was a defensible purchase by conservative investors well into the 1990s. But at some point, management’s unwillingness to grapple with future technological risks outweighed the company’s historical positives. All the past dividend growth in the world won’t help you if future profits are going to decline inexorably.
Target: A Deer In Amazon’s Headlights
Like Kodak, Target has long been aware of the digital threat. Target founded Target.direct in the year 2000, and in 2002, partnered with Amazon.com (AMZN) to fulfill its digital orders.
In 2009, Target launched a new Target.com platform, and in 2011, it finally cut all ties with Amazon.
If you’re thinking back to the tragic end of Borders bookstores, you’re right on the money. Borders infamously partnered with Amazon back in 2001 and didn’t break off the relationship until 2008, when Amazon had almost finished destroying Borders entirely; they’d go bankrupt shortly thereafter.
Barnes & Noble (BKS), for all its problems, was smart enough to realize it had to fight Amazon directly rather than rolling over. The digital initiatives have had mixed results, but management at least looked forward and created some innovative shots on goal such as the Nook.
Target has taken a very lackadaisical approach to the internet, and its recent earnings have shown the danger with this approach. Target is not among the top 10 e-tailers in the US; a really pitiful performance for a company with such a strong physical presence and which has been online in some form or another for the past 17 years. For one particularly bitter comparison, Target’s website only generates 20% more sales than Sears’ (NASDAQ:SHLD).
Wal-Mart hasn’t been an immediate success online either. But unlike Target, management keeps trying, and when faced with a setback, it invests more money in the digital platform. Despite its struggles over the years, Wal-Mart is now the US’ #2 online retailer, trailing only Amazon.
DGI folks have complained that Wal-Mart isn’t raising its dividend quickly enough lately. But look at what Wal-Mart is doing. They’re investing heavily in the digital platform, including a potentially game-changing deal for Jet.com. Overseas, Wal-Mart is making smart partnerships, including acquiring 10% of China’s best-run etailer, JD.com (JD).
It’d be hyperbole to say Wal-Mart’s online strategy has been particularly great. But the company is using its resources to build a credible online presence while its physical stores still produce massive cash flow. As long as Wal-Mart continues investing online prodigiously, it will produce results for its efforts. It’s unlikely that the US will end up with just one digital marketplace – antitrust reasons alone suggest as much – and as long as Wal-Mart firmly controls the #2 spot, its future should be reasonably good.
Target, on the other hand, ranks behind Costco (COST), QVC, Home Depot (HD), Nordstrom (JWN) and other such not particularly impressive online retailers. Despite having a massive physical store presence, Target has managed virtually no integration between that and its digital offerings.
No Safe Harbor Overseas Either
Wal-Mart’s other key advantage (and one badly underrated by investors) is how strong it is overseas. Yes, Amazon may be eating everyone’s lunch in the US. But for companies with a strong foreign presence, Amazon is less of a hassle. Wal-Mart, for example, is the largest employer in Mexico. Amazon’s web presence here in Mexico is quite poor, and infrastructure issues would make it difficult for Amazon to present an equivalent-quality service here even if they tried to.
In other words, whatever your projection for physical stores’ sales decline in the US, I figure you have at least a decade if not more of peak sales in Wal-Mart’s big emerging markets such as Brazil, Mexico, and South Africa. Even if US profits fall off faster than expected, Wal-Mart has a huge run of free cash flow coming in from less developed markets overseas to shoulder the blow.
Target, by contrast, has what? Nothing. Target’s failed expansion into Canada has become the well-deserved butt of jokes. Somehow, the company managed to lose almost $7 billion in Canada in just a couple of years, becoming one of the biggest business failures in Canadian history.
Read through the account of Target’s failure (if you’re long TGT stock, please read this and come back – I’ll wait, it’s important). It’s clear Target management in Minnesota had no idea what they were doing.
Target’s total lack of an overseas business makes their recent performance even more baffling. Wal-Mart, with its huge foreign presence, has been suffering from the strong US dollar. Its sales in markets such as Mexico retain less and less value the farther the Peso and other emerging market currencies devalue.
On the other hand, Target largely buys its products from overseas, benefiting from a strong exchange rate with the dollar at present, and then generates virtually 100% of its revenues in US dollars. Target should be outperforming Wal-Mart, Costco, and other retailers in this market environment. Instead, it’s putting up putrid results despite having a strong tailwind at its back.
Why Is It A “Wonderful” Company?
A recent article here at Seeking Alpha suggested that Target is a “bull’s eye” for DGI portfolios given the recent price drop, based on this rationale:
Because of these sales drops, and bad publicity, Target sells at a discount to its fair price. This presents the DGI investor with the opportunity to take advantage of one of Warren Buffett’s famous adages. The advantage of buying a wonderful company is that the investment continues to grow and throw off more cash over time […]
The great thing is that Target has managed to survive some big mistakes (Canada) and can still return to the growth machine it once was, which to me is a hallmark of a wonderful company. At worst, investors can continue to collect a growing dividend, which for my DGI portfolio is all I need.
But merely “surviving” big mistakes doesn’t make a company wonderful. Sure, a company as large as Target can blow $6 billion in Canada and keep on ticking. It’s a loss of 20% of your market cap, which is a real blow, but not an extinction event.
The return to growth is a question mark though. Here are earnings (stripping out one-time events) over the past five years (data from Gurufocus) :
Does this look like much of a growth machine to you? Recurring profits are unstable and have shrunk by almost 10% over the past five years, despite Target profiting from a strong dollar tailwind.
Target’s revenues are up by less than 10% since 2009. That’s anemic performance in a long-running economic expansion; couldn’t even keep up with inflation. Since 2012, revenues have outright declined. Again, where’s the growth story?
Yes, proponents can tout Target’s new smaller store roll-out. But the last time Target rolled out new stores, Canada happened. And it’s not like small stores is a new concept; they’re years behind Wal-Mart on that front. Wal-Mart in fact already largely gave up on the idea. It’s classic behavior by failing companies to recycle the ideas of better ones.
Avoid Target: The Dividend May Be A Return Of Capital
Imagine I offer you an investment that pays a 5% dividend for 20 years and then is worth nothing. That’d be a pretty lousy annuity, offering no actual monetary return over the years.
I fear that’s what Target buyers of late will be getting. Target’s book value has shrunk from $25 in 2014 to just $19 today. Yes, the company is very profitable today, but what happens in 10 or 20 years when physical stores are just a break-even proposition in most markets? When Target has no digital presence or foreign operations at that point, what value, if any, does the business retain?
Already, the company is busy returning the profits it earns to shareholders. That’s fine, it’s a classic dying business model. But the stream of cash coming has to exceed the price you pay by a significant margin to justify such a “cigar butt” investment. At a less than 4.5% yield, I’m far from convinced Target will offer reasonable returns for shareholders if the company doesn’t return to growth. If Target pays its current dividend for the next 20 years and then files for bankruptcy, you’d outright lose money, not even accounting for inflation or taxes. Future business prospects matter.
And if you are banking on Target growing again, what exactly are you basing your thesis on?
A company like Macy’s (NYSE:M), whose online platform generates twice as much revenues as Target’s, is already up to a 4.8% yield. Many investors who would avoid Macy’s due to the Amazon threat are still happy to own Target. But what’s the difference, really? I concur fully with Nicholas Ward, there’s no need to buy Target’s dip.
Ian is now an associate analyst with the top-ranked Value Investor’s Edge service. If you are interested in getting exclusive deep value and trading research from three of SA’s top authors, learn more here.
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