Going Into Earnings, Is Target Stock a Buy, a Sell, or Fairly Valued?

Target TGT is set to release its first-quarter earnings report. Here’s Morningstar’s take on what to look for in Target’s earnings and stock.

Key Morningstar Metrics for Target

• Fair Value Estimate: $136.00
• Morningstar Rating: 2 stars
• Morningstar Economic Moat Rating: None
• Morningstar Uncertainty Rating: Medium

Earnings Release Date

• Wednesday, May 22, 2024, before the start of trading

What to Watch for In Target’s Q1 Earnings

• What are consumers spending money on? We expect Target’s more discretionary categories, such as home furnishings, apparel/accessories, and hardlines, to remain weak while its food/beverage and beauty/household essential categories perform well. But we are curious about signs that spending on discretionary goods is increasing again.
• Are there any signals that promotional discounting is weighing on gross margins? Target’s gross and operating margins have meaningfully improved since 2022, and the retail industry’s inventories seem good. There weren’t any clear hints from Walmart WMT that competition among retailers is getting more stringent, but we will be curious about what Target says about the competitive landscape and discounting activity.
• Management’s 2024 sales guidance was lackluster (0%-2%), but its full-year EPS guidance was favorable. We will be interested to hear whether cost reductions (primarily in selling, general, and administrative expenses) and efficiency initiatives are keeping the bottom line healthy.

Fair Value Estimate for Target Stock

With its 2-star rating, we believe Target’s stock is overvalued compared with our long-term fair value estimate of $136 per share. The company’s bottom line easily outpaced our expectations amid better-than-expected margin improvement, and management issued fiscal 2024 comparable sales guidance that exceeded our forecast. As such, the uptick in our fair value estimate stems primarily from the time value of money and our upward adjustment to our fiscal 2024 comp sales outlook—we raised our forecast to a 50-basis-point increase compared with our prior expectations for a low-single-digit decline.

Despite our more optimistic near-term growth outlook, we maintain our contention that Target lacks a durable competitive edge in an intensely competitive retail landscape, keeping our long-term top-line and margin outlook intact. Our fair value estimate implies a forward fiscal 2024 adjusted price/earnings ratio of 15.0 times and enterprise value/adjusted EBITDA of 8.4 times.

Read more about Target’s fair value estimate.

Economic Moat Rating

We do not believe Target warrants an economic moat. Despite its iconic and trendy brand, we view its position in the hypercompetitive retail environment as rather ambiguous, which dilutes our confidence in the durability of its brand to drive consistent store traffic. Furthermore, we don’t see sufficient evidence to award Target a cost advantage. Although it is the nation’s sixth-largest retailer, we do not believe it exhibits an irreplicable scale across its product categories that would suggest it has amassed negotiating prowess over its supplier partners.

Read more about Target’s economic moat.

Financial Strength

After three years in which it saw its top line balloon by nearly 40%, Target finds itself in a strong financial position, with a conservative debt ratio (net debt/2023 EBITDA stood at 1.2 times) and ample liquidity. At the end of its 2023 fiscal year, the retailer had about $14 billion in debt and held $3.8 billion in cash (plus $4 billion in an untapped revolving facility). This is consistent with its past mantra, as the company has prioritized operating with a strong balance sheet for over two decades (net debt/EBITDA has averaged 1.6 times since 2000).

Read more about Target’s financial strength.

Risk and Uncertainty

We assign Target a Medium Uncertainty Rating. The rise of digital penetration is a formidable threat to the company’s traditional brick-and-mortar retail model. Price shopping has become seamless as consumers increasingly begin their product searches via digital channels, making Target susceptible to price competition in an industry where consumers face virtually no switching costs. The retail industry’s preemptive leaders, Walmart and Amazon AMZN, boast an unrivaled scale and an impressive ability to invest in supply chain automation to mitigate costs. We expect those firms to serve as disinflationary forces in the industry for years to come, pressuring retailers that lack a differentiated product offering, vast scale, or concentrated geographic focus. (We believe Target falls into all three categories.) We think gross margins may be pressured over the following decade.

Read more about Target’s risk and uncertainty.

TGT Bulls Say

• Given its iconic brand that promises a more gratifying customer experience than other low-cost retailers, we are confident in Target’s ability to drive recurring foot traffic.
• Based on its performance during the covid-19 pandemic, we view Target as a formidable online retailer, putting to rest many concerns about its ability to compete in a digital retail environment.
• Target is poised to benefit from the continued decline of mall-based competition and department stores, which will drive strong growth in comparable sales.

TGT Bears Say

• Target lacks the scale and differentiation to drive significant market share across its product categories since its offerings lack a clear value proposition.
• Despite being the nation’s sixth-largest retailer, Target must constantly invest in cost-saving initiatives, product innovation, and store renovations to keep up with Walmart and Amazon.
• Target’s higher-margin discretionary product categories, such as apparel and home furnishings, are susceptible to losing market share via digital retail penetration, which could weaken its margins.

This article was compiled by Krutang Desai.