Target: Rehabilitated Brand, Technology, And A Low Valuation (NYSE:TGT)
It's not often that I make a total about-face when it comes to my views on companies. In fact, I can't recall a single instance where I went from extremely bearish on a stock to bullish. Until now, that is.
I admit that I was wrong about Target (TGT). After a decade-long slump in share price, the company's stock has been on a tear, up more than 50 percent over the last year. Much of the recent success has been due to the pandemic and Target's "essential business" status, but the seeds were sown several years ago.
Today, I see the stock as being undervalued. Not only is the stock inexpensive compared to the S&P 500, but the market does not appear to appreciate the value of Target's e-commerce initiatives and strong growth in private label brands.
Target's Turnaround
Three years ago, my article bashing Target's stagnant corporate culture and strategic missteps generated a lot of controversy. Reading it again today, I still think that many of my observations were correct. Target did have many problems. But I did make one mistake, and that was underestimating the managerial prowess of CEO Brian Cornell.
When Cornell announced a $7 billion investment in physical stores in 2017, Wall Street turned up its nose. Most analysts thought Target should be closing stores, not opening new ones. The stock plunged 12 percent the day of the announcement, a dubious record for the company. But the plan worked. Over the last few years, I have noticed that the Target stores in Greater Boston, many of which were badly outdated, have been remodeled quite nicely. The same is true for most locations in Target's fleet.
Target also successfully reinvigorated its foundering private label brands, which had suffered from neglect. Six of Target's in-house labels are billion-dollar brands, mostly in apparel. A New Day, created in 2017 for women, reached $1 billion in sales within one year. Children's brand Cat & Jack became a $2 billion business line in the same amount of time. These successes helped drive comparable same store sales up 5 percent year-over-year in late-2019.
Target and the Pandemic
Although Target struggled for years to get its grocery act together, the pandemic provided a massive lift to the business line. Grocery helped drive Q1 sales growth by double digits, even as profits temporarily cratered due to customers pulling back on buying higher-margin items such as apparel.
Much of that success can be attributed to Target's purchase of personal shopping app Shipt in late-2017. The acquisition price of $550 million now seems like an astonishing bargain. Instacart recently raised capital at a valuation of $14 billion, a figure more than double its early-2018 valuation. I think Shipt could be worth as much as $5 billion based on a size comparison with the larger competitor.
The beauty of Shipt is that it allows for Target to be competitive in grocery/personal shopping without taking a massive hit to the bottom line. Instacart turned profitable this year on surging demand for its services. Like Instacart, Shipt charges a $99/year membership fee to cover costs.
Online grocery delivery is projected to grow 40 percent in 2020 to $38 billion. Projections made before the pandemic estimated that it could be a $100 billion industry by 2025. Consider that Target brought in revenue of $75 billion in 2019. Even a small slice of that market would move the needle massively for the company.
With non-essential competitors struggling, Target finds itself in a strong position to grab market share and expand its customer base. If the pandemic stays with us past 2021, which seems likely at this point, Target is poised to benefit. My own anecdotal experience suggests as much, with mundane items such as socks and underwear frequently sold out at Target stores in Boston. This bodes well for Q2 earnings, where hopefully the retailer will show stronger sales of more profitable business lines.
Despite these huge positives, Target's valuation remains flat from December 2019. The stock's P/E of 24 is well below the market's ratio of 29 times earnings. The market sees Target as nothing more than a brick-and-mortar retailer, when really it should be viewed as a retailer incubating an important technology startup (Shipt). With so many positives at a modest valuation, I see Target shares as a safe haven for the future.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in TGT over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Gloss