Target (TGT 0.18%) has been in existence since the early 1900s. The venerable retailer became a popular destination by offering private-label and exclusive items that separate it from other retailers.
With a large presence and established brand recognition, Target clearly did a lot of things right to become a successful company. But past success doesn't guarantee future results, as astute investors well know.
Is Target well-positioned to reward shareholders?
Image source: Getty Images.
A misstep
A couple of years ago, management built up inventory in the wrong categories. It stocked up too much on discretionary goods and not enough on everyday items like food, beverages, beauty, and household essentials.
It was a costly mistake to underestimate how much its core customer was impacted by macroeconomic factors such as elevated inflation, and Target was forced to discount items to pare inventory.
Fortunately, there's evidence that this step put Target in a better position. It had $11.9 billion in inventory at the end of the fiscal fourth quarter, which ended on Feb. 3. That's down from $13.5 billion a year ago.
And its fourth-quarter gross margin expanded from 22.7% to 25.6%. Management partly credited the improvement to lower markdowns.
Faltering sales
While it's positive that the need to offer fewer discounts has diminished, that doesn't mean everything's going well for Target. Its sales continue to slump. Fourth-quarter sales actually grew 1.6%. But this was due to an extra week last year.
A better measure is same-store sales (comps). Target's fourth-quarter comps fell 4.4%. Management expects comps to drop by 3% to 5% in the first quarter. With the store count remaining at roughly 2,000, comp increases will drive the majority of sales growth.
Dividend appeal
For income-oriented investors, Target may have some appeal. The board of directors has paid a dividend since the stock's 1967 public offering. Better still, having raised its dividend for more than a half-century, the stock belongs to the elite Dividend Kings.
Target generates plenty of free cash flow (FCF) to support the payments. Last year's FCF was $3.9 billion, easily covering the $2 billion in dividends. The stock has a 2.6% dividend yield, nearly double the S&P 500's 1.4%. Target didn't use any of its FCF to repurchase shares, however. But it spent $2.6 billion in the previous year.
The decision
Target's share price spiked following its recent earnings announcement. Shares soared from about $150 to their current peak above $170. The stock has gained about 55% since the end of October.
That also means the valuation has become richer. The stock's price-to-earnings (P/E) ratio has gone from about 14 to 19 during this span. Clearly, many investors have become more optimistic about Target's prospects. Should you jump on board?
With slumping sales, I'd hold off for now. Target's customers don't seem ready to trade up and buy discretionary higher-margin items. While dividend-seeking investors may wish to hold on, I'd pass on buying new shares. For those seeking growth-oriented opportunities, I'd sell the shares and look for a different stock.
