Stock of the week - Target (16.11.2023)

• Target released fiscal-Q3 2024 earnings report on Wednesday
• Company beat sales and profit expectations
• Solid results supported by better inventory management
• Company issued better-than-expected fiscal-Q4 guidance
• Stock made the biggest one-day jump in 4 years!
• A look at valuation

Target (TGT.US) rallied by almost 18% on Wednesday, following release of fiscal-Q3 2024 earnings report (August - October 2023).  Company beat analysts' expectations, especially in case of profits, and issued an upbeat fiscal-Q4 guidance. Let's take a quick look at recent earnings release as well as how the company's valuation looks like following yesterday's massive rally.

Fiscal-Q3 earnings smash expectations

Earnings release for Target for fiscal-Q3 2024 turned out to be a huge positive surprise. While sales dropped 4.3% YoY to $25.00 billion, they were slightly better than expected by analysts. Drop in comparable sales was also smaller than expected. The biggest surprise came from reported profits, with operating income jumping 29% YoY to $1.32 billion and EBITDA coming in at $2.06 billion against the expected $1.67 billion. Drop in average transaction amount was smaller than expected while Selling, General & Administrative costs (SG&A) increasing less than expected.

Earnings were supported by fewer markups and improved inventory management, with inventory levels dropping 14% from a year ago quarter. While spending on discretionary items remained weak amid overall weaker consumer spending in a high-inflation and high-interest rate environment, company said that it saw strong performance in so-called 'frequency' categories. Those categories include products that are likely to see repeated purchases, like for example beauty products or food.

Target expects a strong fiscal-Q4 2024 (November 2023 - January 2024 period) as well. Company expects adjusted EPS to reach $1.90-2.60 in fiscal-Q4, with midpoint of the range ($2.25) coming in slightly above the expected $2.23. 

Fiscal-Q3 2024 earnings

• Sales: $25.00 billion vs $24.88 billion expected (-4.3% YoY)
• Comparable sales: -4.9% YoY vs -5.2% YoY expected
• Gross margin: 27.4% vs 26.3% expected
• Operating margin: 5.2% vs 3.9% expected
• Operating income: $1.32 billion vs $1.0 billion expected (+29% YoY)
• EBITDA: $2.06 billion vs $1.67 billion expected
• Adjusted EPS: $2.10 vs $1.47 expected
• SG&A expense: $5.32 billion vs $5.35 billion (+1.9% YoY)
• Average transaction amount: -0.8% YoY vs -1.4% YoY expected
• Customer transactions: -4.1%
• Total stores: 1 956 vs 1 965 expected

Fiscal-Q4 2024 forecast

• Adjusted EPS: $1.90-2.60 vs $2.23 expected

While the earnings beat reported by Target for fiscal-Q3 2024 was of a similar magnitude as the one reported in fiscal-Q4 2023, day-ahead price reaction was much larger. Source: Bloomberg Finance LP, XTB

Target makes the biggest 1-day jump in 4 years!

Fiscal-Q3 2024 results showed a deterioration in sales compared to a year-ago quarter, but improvement in margins has driven strong earnings growth. Solid earnings combined with a better-than-expected release of US retail sales data for October was a perfect mix for Target stock to rally. However, the scale of the move higher yesterday likely surprised everyone. The stock rallied over 17.7%, marking the biggest single day jump since August 2019, when the company's shares surged 20% following release of a rather mixed fiscal-Q2 2020 earnings report. This was also the third-biggest single day jump for Target stock since the beginning of 2000!

Source: Bloomberg Finance LP, XTB

Valuation

Let's take a quick look at Target's valuation with 3 often used valuation methods - DCF, multiples and Gordon Growth Model. We want to stress that those valuations are for presentation purposes only and should not be viewed as recommendations or target prices.

Discounted Cash Flow method

Let's start with probably the most popular fundamental model for valuing stocks - Discounted Cash Flow method (DCF). This model relies on a number of assumptions. We have decided to take a simplified approach and base those assumptions on averages for the past 5-years. Detailed forecasts for 10 years were made with terminal value assumptions being set as follows - 2% terminal revenue growth and 7% terminal weighted cost of capital (WACC). Such a set of assumptions provides us with an intrinsic value of Target's shares of $188.49 - or almost 45% above yesterday's cash close. Terminal value forecast accounts for 65% of DCF valuation.

A point to note is that the intrinsic value obtained via the DCF method is highly sensitive to assumptions made. Two sensitivity matrices are provided below - one for different sets of Operating Margin and Revenue Growth assumptions and the other for different sets of Terminal WACC and Terminal Revenue Growth assumptions.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Multiples

Next, let's take a look at how Target's valuation compares with peers. We have constructed a peer group consisting of 19 companies Target mentioned as its rivals in 2022 annual report. Those include Albertson Companies, Amazon, Best Buy, Costco Wholesale, CVS Health, Dollar General, Dollar Tree, GAP, Home Depot, Kohl's, Kroger, Lowe's, Macy's, Nordstrom, Rite Aid, Ross Stores, TJX, Walgreens Boot Alliance and Walmart. We have taken a look at 6 different valuation multiples - P/E, P/BV, P/S, P/FCF, EV/Sales and EV/EBITDA.

As the peer group is large, we have provided aggregated data for Target's peers instead of data for each of company's rivals. We have presented a mean, median and cap-weighted values for multiples. As some of Target's rivals are massive in terms of market capitalization (Amazon, Home Depot, Walgreens Boots Alliance and Walmart) and significantly distort cap-weighted multiples, we have also provided a trimmed cap-weighted multiples that are calculated after excluding the aforementioned four Target's rivals from the group.

As one can see, regardless of the way we choose to value Target in relation to peer multiples, valuations point to the company being undervalued.

Source: Bloomberg Finance LP, XTB Research

Gordon Growth Model

Let's move to the third valuation method - Gordon Growth Model. This method relies on dividends and given that Target has a long track record of dividend payouts, it can be used to value company's stock. We have assumed a 5% dividend growth rate as well as 8% required rate of return. Such a set of assumptions provides us with a valuation of $144.9 per Target's share - or around 11% above yesterday's cash close.

As it is usually the case with valuation models, the Gordon Growth Model is also highly sensitive to assumptions made. Sensitivity matrix for dividend growth and required rate of return assumptions is provided below. Green tiles show combinations that result in above-market valuation and red tiles show combinations that result in below-market valuations.

Source: Bloomberg Finance LP, XTB Research

A look at the chart

Target (TGT.US) has been trading in a downward move since mid-November 2021. The stock has lost over 60% in value between mid-November 2021 peak and early-October 2023 low.  Taking a look at the chart at D1 interval, we can see that the share price jump yesterday was massive and pushed the stock to the highest levels since late-August 2023. 

However, even such a big jump does not change much in terms of a technical picture on the chart. While stock managed to jump above the $127.50 resistance zone, that acted as the lower limit of a trading range earlier this year, it has failed to move above a short-term downward trendline. Should we see gains continue in the coming session, the near-term resistance level to watch can be found in the $138.50 area, marked with previous price reactions as well as the 200-session moving average. A move above the trendline and 200-session moving average would brighten the outlook for bulls, but according to the Overbalance methodology, a jump above the upper limit of market geometry in the $175 are would be needed to confirm trend reversal.

Source: xStation5