One of the cheapest stocks in our Large Cap 1000 Stock Screener is Target Corporation (NYSE:TGT).
Target Corporation (Target) is a general merchandise retailer selling products through its stores and digital channels. Its general merchandise stores offer an edited food assortment, including perishables, dry grocery, dairy and frozen items. Its digital channels include a range of general merchandise, including a range of items found in its stores, along with an assortment, such as additional sizes and colors sold only online.
Its owned brands include Archer Farms, Market Pantry, Sutton & Dodge, Art Class, Merona, Threshold, Ava & Viv, Pillowfort, Room Essentials, Wine Cube, Cat & Jack, Simply Balanced and Wondershop. Its exclusive brands include C9 by Champion, Hand Made Modern, Mossimo, DENIZEN from Levi’s, Nate Berkus for Target, Fieldcrest, Kid Made Modern, Genuine Kids from OshKosh and Liz Lange for Target. As of January 28, 2017, the Company had 1,802 stores across the United States, including 1,535 owned stores, 107 leased stores and 160 owned buildings on leased land.
A quick look at Target’s share price history over the past twelve months shows that the price is down 25%, but here’s why the company is undervalued.
(Source: Google Finance)
The following data is from the company’s latest financial statements, dated April 2017.
The company’s latest balance sheet shows that Target has $2.680 Billion in total cash and cash equivalents. Further down the balance sheet we can see that the company has short-term debt of $1.717 Billion and long-term debt of $11.086 Billion. Therefore, Target has a net debt position of $10.123 Billion (debt minus cash). While some investors may be concerned about Target’s net debt position it’s important to consider the company’s free cash flow position below.
In terms of the company’s overall financial strength, all financial strength indicators show that Target remains financially sound with a Piotroski F-Score of 5, an Altman Z-Score of 3.19, and a Beneish M-Score of -2.99.
If we consider that Target currently has a market cap of $30.954 Billion, when we add the net debt totaling $10.123 Billion that equates to an Enterprise Value of $41.077 Billion.
If we move over to the company’s latest income statements we can see that Target has $4.835 Billion in trailing twelve month operating earnings which means that the company is currently trading on an Acquirer’s Multiple of 8.49, or 8.49 times operating earnings. That places Target squarely in undervalued territory.
The Acquirer’s Multiple is defined as:
Enterprise Value/Operating Earnings*
*We make adjustments to operating earnings by constructing an operating earnings figure from the top of the income statement down, where EBIT and EBITDA are constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–income that a company does not expect to recur in future years–ensures that these earnings are related only to operations.
It’s also important to note that if we take a look at the company’s latest cash flow statements we can see that Target generated trailing twelve month operating cash flow of $6.492 Billion and had $1.748 Billion in Capex. That equates to $4.744 Billion in trailing twelve month free cash flow, or a FCF/EV Yield of 12%. The company has used this free cash flow wisely by spending $3.125 Billion (ttm) buying back shares, while the price is undervalued, and paying out dividends totaling $1.344 Billion (ttm). Both of which provide shareholders with a shareholder yield of 14% (buyback yield 10% + dividend yield 4%).
Some analysts will point to the company’s current revenue of $69.316 Billion (ttm) and net income of $2.786 Billion (ttm) and make comparisons with FY2016 when revenues were $73.785 Billion and net income was $3.363 Billion but its important to consider that in FY2016 the company had $4.406 Billion in free cash flow compared to the $4.744 Billion (ttm) that we see today. That’s an 8% increase in free cash flow (ttm) and an all time high. What’s also important to consider is that the company’s current EPS of $4.88 (ttm) is the second highest in the past ten years and its current dividend of $2.36 (ttm) is an historical high.
Lastly, its also worth taking a look at Target’s annualized Return on Equity (ROE) for the quarter ending April 2017. A quick calculation shows that the company had $10.953 Billion in equity for the quarter ending December 2016 and $11.021 Billion for the quarter ending April 2017. If we divide that number by two we get $10.987 Billion. If we consider that the company has $2.786 Billion (ttm) in net income, that equates to an annualized Return on Equity (ROE) for the quarter ending April 2017 of 25%.
With all of this in mind it is therefore difficult to understand Target’s current P/E of 11.7 compared to its 5Y average 17.4**, and even more difficult to understand when you consider that the company traded on a P/E of 30+ in March of 2015:
(Source: Morningstar)
In terms of the company’s current valuation. Target is a company that is currently trading on a P/E of 11.7 compared to its 5Y average of 17.4**, a FCF/EV Yield of 12%, and an Acquirer’s Multiple of 8.49, or 8.49 times operating earnings. The company is currently generating historically high free cash flow and has an annualized Return on Equity (ROE) for the quarter ending April 2017 of 25%. This is in addition to its shareholder yield of 14% (buyback yield 10% + dividend yield 4%). All of which indicate that Target is currently undervalued.
** Morningstar
About The Large Cap 1000 Stock Screener (CAGR 18.4%)
Over a full sixteen-and-a-half year period from January 2, 1999 to July 26, 2016., the Large Cap 1000 stock screener generated a total return of 1,940 percent, or a compound growth rate (CAGR) of 18.4 percent per year. This compared favorably with the Russell 1000 Total Return, which returned a cumulative total of 259 percent, or 5.6 percent compound.
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