Finanzas: Is Costco Really Worth Twice As Much As Target?

Fachada de una tienda de la cadena Costco

 

Summary

  • In the brick and mortar retail space, Costco is drastically outperforming much of its competition.
  • It seems as though this wholesale corporation is better suited to compete against Amazon and the e-Commerce revolution; but, is the market pricing the stock rationally?
  • Costco’s P/E premium is more than twice as high as beaten down Target’s. In this piece, I look into this discrepancy to see if it’s justified.

Lately, I’ve been following the retail industry very closely. There’s a lot of interesting things happening here; it seems as if we’re at a crossroads of sorts and it’s difficult to decide where I should be putting my money. I recently wrote a bullish piece focused on Amazon (NASDAQ:AMZN). Ultimately, I think that they will continue to dominate the space and will prove to be a long-term winner. However, outside of Amazon, especially in the big box brick and mortar space, there are several intriguing opportunities in the market today. The recent selloffs of Target (NYSE:TGT) and Macy’s (NYSE:M) come to mind, with their yields rising way above historical norms. I don’t necessarily think that there has to be one winner and a bunch of losers here; retail is a massive market, and right now, I’m trying to position myself well regarding winners and losers, once the dust settles a bit and the industry establishes a new e-commerce era norm.

When looking at companies within the retail space, one of the most interesting comparisons that I’ve come across recently is Costco (NASDAQ:COST) versus Target. Both companies have experienced weakness as of late due to fears of the potential secular headwind that is e-commerce, as well as political overhangs that could hurt their industry as a whole. However, in the market’s opinion, at least, one of these companies still reigns supreme. Costco’s forward P/E ratio is 29.6x. Target’s is 13.25x.

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When I saw this discrepancy, I was taken aback. Frankly put, even though I knew TGT was facing several serious operational issues, I had a hard time believing that COST really deserved such a high premium on a relative basis. In this piece, I’ll be delving deeper to see why COST has a valuation that is more than twice as high as Target’s and whether or not this is a rational decision by the market.

Dividends

First things first, let’s take a look at the dividends involved in this comparison. Typically, when I invest in the retail sector, I’m focused on income, rather than growth.

As you can see, Target has the much higher yield. The company’s 4.5% yield is what attracts me to the shares. Costco, on the other hand, is yielding just above 1%, so obviously TGT wins this round.

As a dividend growth investor, it’s not just dividend yield that I focus on, but dividend growth. I look both forward and backwards when analyzing dividend growth, to track a company’s ability to continue to increase its dividend into the future and to gauge a company’s long-term quality of earnings and management’s history of generosity to its shareholders.

Sugerimos: http://www.america-retail.com/usa/usa-targets-store-makeover/

So, when looking at dividend growth, we see that both companies being compared here do a great job. Both COST and TGT offer investors double-digit 5-year dividend growth rates. However, it’s important to acknowledge that COST’s most recent dividend increase was significantly larger than TGT’s. One year doesn’t make a trend, though it appears that TGT’s dividend growth is slowing. COST, on the other hand, has given investors double-digit dividend increases every year since 2004, and their trend remains intact. We’ll take a look at this in a minute, but COST has had better EPS performance in recent years, and if I had to guess which company will do better growing its dividend moving forward, I’d choose COST, without a doubt.

Regarding past performance of EPS/dividend growth, I think investors should be cautious when making estimates of future dividend growth in the retail space because the border tax and/or e-commerce taking market share issues are real and could do serious damage to sales, margins, and profits from brick and mortar retail companies. When looking at dividend metrics, it’s important to acknowledge that a company’s EPS and sales growth are what ultimately support the growing dividend over time and these two companies appear to be facing strong headwinds in the present that could affect the attractiveness of their dividends if their management teams can’t navigate these tumultuous waters. I remain cautiously optimistic, though because of risks associated with companies operating in this space, I require a wide margin of safety before purchasing shares.

With all of that said, in general, I find both companies attractive from an income point of view. I’m a bit bearish on the retail space, if you aren’t, then these yields become even more attractive. Target as a high yielding dividend champion with ample dividend coverage over the coming years, regardless of near-term EPS related headwinds, and Costco, as a potential up and coming dividend champion, whose above average DGR will lead to a much more respectable yield (and potentially massive yields on cost for investors in the present) over time.

Comparative Performance

Now, let’s take a look at the charts. Here are 1- and 5-year charts of the Target vs. Costco share price comparison. As you can see, the race isn’t a close one. Since March of 2012, COST is up ~85%, while TGT is down ~10%. Since last March, COST is up ~10%, while TGT is down ~35%. TGT is currently trading down 36.84% from its 52-week high, while COST is down just 6.61%. For a high flying company like COST, 6.61% might seem like a significant pullback, though it pales in comparison to TGT’s massive selloff.

As you can see, Target has the much higher yield. The company’s 4.5% yield is what attracts me to the shares. Costco, on the other hand, is yielding just above 1%, so obviously TGT wins this round.

As a dividend growth investor, it’s not just dividend yield that I focus on, but dividend growth. I look both forward and backwards when analyzing dividend growth, to track a company’s ability to continue to increase its dividend into the future and to gauge a company’s long-term quality of earnings and management’s history of generosity to its shareholders.

So, when looking at dividend growth, we see that both companies being compared here do a great job. Both COST and TGT offer investors double-digit 5-year dividend growth rates. However, it’s important to acknowledge that COST’s most recent dividend increase was significantly larger than TGT’s. One year doesn’t make a trend, though it appears that TGT’s dividend growth is slowing. COST, on the other hand, has given investors double-digit dividend increases every year since 2004, and their trend remains intact. We’ll take a look at this in a minute, but COST has had better EPS performance in recent years, and if I had to guess which company will do better growing its dividend moving forward, I’d choose COST, without a doubt.

Regarding past performance of EPS/dividend growth, I think investors should be cautious when making estimates of future dividend growth in the retail space because the border tax and/or e-commerce taking market share issues are real and could do serious damage to sales, margins, and profits from brick and mortar retail companies. When looking at dividend metrics, it’s important to acknowledge that a company’s EPS and sales growth are what ultimately support the growing dividend over time and these two companies appear to be facing strong headwinds in the present that could affect the attractiveness of their dividends if their management teams can’t navigate these tumultuous waters. I remain cautiously optimistic, though because of risks associated with companies operating in this space, I require a wide margin of safety before purchasing shares.

With all of that said, in general, I find both companies attractive from an income point of view. I’m a bit bearish on the retail space, if you aren’t, then these yields become even more attractive. Target as a high yielding dividend champion with ample dividend coverage over the coming years, regardless of near-term EPS related headwinds, and Costco, as a potential up and coming dividend champion, whose above average DGR will lead to a much more respectable yield (and potentially massive yields on cost for investors in the present) over time.

Comparative Performance

Now, let’s take a look at the charts. Here are 1- and 5-year charts of the Target vs. Costco share price comparison. As you can see, the race isn’t a close one. Since March of 2012, COST is up ~85%, while TGT is down ~10%. Since last March, COST is up ~10%, while TGT is down ~35%. TGT is currently trading down 36.84% from its 52-week high, while COST is down just 6.61%. For a high flying company like COST, 6.61% might seem like a significant pullback, though it pales in comparison to TGT’s massive selloff.

Now, looking at these, it’s clear that COST is a better performer. COST has grown revenues each of the past 5 years; that’s something that TGT cannot say. However, the revenue growth trend appears to be slowing for COST, which is a problem for me, especially when the company is trading for nearly 30x its forward earnings. COST’s EPS performance is also much better/steadier than TGT’s, though like TGT, it experienced a massive slowdown of EPS growth during the most recent fiscal year. Basically, when looking at these figures, I come to the conclusion that COST is without a doubt a superior operation compared to TGT, though I don’t believe that the company’s performance can justify the market’s pricing of the stock.

What Is Fair Value?

Before, I talked about wanting a wide margin of safety when purchasing shares in this industry due to perceived headwinds and threats to current business operations and market share levels. So, with that in mind, I wanted to take some time to discuss my fair value for each company in this comparison, to see which is currently priced closer to my calculation.

Generally, I’m much more bearish on TGT’s forward prospects regarding growth than I am Costco’s. I agree with many who say that the wholesale club model is more «Amazon-proof» than the traditional big box brick and mortar design. I think e-commerce will continue to take market share away from the likes of TGT and to combat this trend, TGT will have to lower prices and therefore, margins to compete, while cannibalizing its own traditional sales with its own digital platform. Because of this, I believe that COST deserves a higher valuation premium than TGT.

TGT’s average analyst estimate for FY2018 EPS is $3.99/share. This is down approximately 20% from FY2107’s total. Management’s guidance for its current fiscal year was what sparked TGT’s recent sharp downturn, and while the pace of the selloff has slowed in recent weeks, the company’s shares still haven’t found a solid bottom. Due to the negative growth trend that TGT is facing, I believe a 12-12.5x earnings multiple is about right as far as premiums go. This is below the company’s long-term normal P/E ratio of 18.5x and 5-year normal P/E of 14.6x; however, I think it’s justified due to the eroding sales and earnings trends that this company offers investors. TGT shares traded for ~10x earnings at the trough of the great recession; I think this just goes to show that my ~12x target isn’t an unheard of multiple for this company during tough times.

Right now, TGT shares are trading for $53.12, or 13.28x the forward $4.00 EPS figure. The current share price equates to a 7.7% premium to the midpoint of my own fair value calculation of $48-50/share.

COST’s average analyst forward EPS estimate $5.65. Unlike TGT, whose figure is 20% below the previous year’s total, COST’s forward average suggests 6% growth. Now, while 6% growth isn’t necessarily a bad result, it is below this company’s recent average, and remains entirely too low to justify the company’s 29.4x forward P/E multiple. I think a 17-19x multiple is about right for a company with COST’s growth prospects. This is a good bit below the company’s long-term normal P/E ratio of 24.1x and 5-year normal P/E of 25.4x. However, even though I said that I’m more bullish on COST relative to TGT, I still think COST faces stronger industry headwinds now than it has in recent memory and these will continue to put pressure on the double-digit growth that COST investors have become accustomed to over recent years. I suspect that COST will post growth in the low-mid single digits moving forward as the retail space evolves and consolidates in the e-commerce era. The midpoint of my fair value range for COST is $101.70. This means that the company’s shares currently trade with a 38% premium to my fair value calculation, which is why I believe shares are currently grossly overvalued.

Conclusion

So, to answer the question that I began with, «is Costco really worth twice as much as Target,» my answer is a solid «no.» I think Costco is a better company than Target, though due to the irrationally high premium that the market has placed on COST shares, TGT’s stock seems like a better stock to buy today. Both companies trade at a premium to my fair value calculations, so I won’t be buying shares of either at current prices, though TGT is much closer to my target price than COST. I think it’s likely that TGT continues to fall into my target range, while I highly doubt that COST will trade at $102/share anytime soon. COST is a market darling type stock and I don’t think it will experience significant weakness unless it blows an earnings report and guides down massively like TGT did recently. I’d much rather buy shares of a beaten down company with lowered expectations than buy shares of a company that are priced for near perfection. As much as I’d love to have exposure to COST in my portfolio because of the company’s dividend history and future growth prospects, I imagine I’ll be sitting on the sidelines with regards to this company for awhile still. I may initiate positions in companies like Target or Macy’s in the near future, though if I do, the positions will remain small, being contrarian in nature with a high yield kicker to help me remain patient as the companies restructure themselves to better fit the market current environment.

 

Fuente: seekingalpha


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