It’s not too often that you find a dividend aristocrat with a 3% dividend yield and 20% annual dividend growth over the past decade.
Target (TGT) just so happens to be one of these stocks. The company has been in business for more than 100 years and will likely be around for the next 100 as well.
Despite the company’s durability, it has faced a number of challenges in recent years – the 2013 data breach, an unsuccessful expansion into Canada, and rising pressure from e-commerce competitors.
Let’s take a closer look at the business and see if these challenges make TGT a worthwhile investment for our Top 20 Dividend Stocks portfolio today.
TGT was incorporated in 1902, but its first discount Target store opened in 1962. The company now has nearly 1,800 locations across the United States. TGT’s stores focus on convenient one-stop shopping and competitive discount prices, offering a broad range of product categories including personal care, beauty, electronics, apparel, food, furniture, appliances, baby care, movies, and much more.
The company is the second largest general merchandise retailer in America, second to only Walmart. Compared to Walmart, TGT is much smaller ($73 billion in sales last year vs $486 billion at Walmart), has less grocery business (21% of sales vs 56% at Walmart) and targets a relatively wealthier demographic. TGT’s typical customer is 40 years old and has a median household income of $64,000. Approximately one-third of TGT’s sales are related to its owned and exclusive brands. The rest of its products are mostly national brand merchandise.
Like most companies with over 100 years of operating history, TGT has not been without its challenges. Many consumers remember TGT’s data breach that exposed about 40 million credit and debit cards to fraud in December 2013.
According to the Wall Street Journal, trade groups representing community banks and credit unions estimate that they spent more than $350 million to reissue credit and debit cards and deal with other issues tied to TGT’s breach and the subsequent Home Depot hack.
TGT settled with Visa for $67 million earlier this year and is expected to strike a similar agreement with MasterCard. The costs of the settlement were already reflected in its 2013 and 2014 results, but the data breach certainly gave TGT a black eye with consumers.
While the data breach was going on, TGT’s former CEO was focused on expanding the company into Canada to drive growth. The company’s strategy was overly aggressive from the beginning as TGT bought 124 locations in 2013 by purchasing all of the outlets from Zellers, a failed discounter with presumably subpar locations. Perhaps things would have turned out differently if the company launched new stores slowly and in locations that had been researched better.
Regardless, store location wasn’t the only problem. TGT faced numerous supply chain challenges that resulted in empty shelves and prices that Canadian shoppers found to be too high. After racking up $2 billion in losses since its creation in 2011, TGT’s former CEO Gregg Steinhafel, who had spent 35 years at the chain, was replaced by Brian Cornell, a hands-on retail guru who helped improve operations at Safeway, Michael’s Sam’s Club, and Pepsi.
After an internal analysis showed that it would take at least six years for TGT’s Canadian division to turn a profit, Cornell quickly decided to discontinue the company’s Canadian operations. TGT closed the last of its Canadian stores in April 2015, ending a $7 billion experiment that also caused TGT to lose some focus with its U.S. business.
However, these challenges are in the past and leave the company better focused on improving its U.S. business.
TGT’s economies of scale create high barriers of entry because it can negotiate more favorable supply contracts with buyers. New entrants would be able to match TGT’s pricing and merchandise quality. Consumers are very price-conscious and have few reasons to shop at pricier retailers offering similar merchandise.
Managing its distribution network and supply chain is another major challenge new operators would need to overcome to compete with TGT. The company has long-lasting relationships with suppliers that often span decades and has invested heavily in logistics to keep its shelves stocked.
Simply put, TGT is not going away anytime soon. Its stores are in good condition, it sells needed merchandise across nearly every product category imaginable, and the company is investing to stay relevant in e-commerce.
TGT is also taking out $2 billion in costs over the next two years which, combined with moderating new store capital expenditures, should make the company a cash cow for years to come.
We have no doubts that TGT’s U.S. stores will continue generating loads of cash to fund the dividend and selective reinvestment back into the business. Our bigger question is growth.
TGT became a giant by filling the suburbs of America with 130,000 square-foot boxes. This industry looks more mature by the day as giants like Walmart struggle to drive incremental growth.
We can see TGT is facing similar reinvestment challenges because its new store growth has all but come to a screeching halt over the last few years:
These are signs of a saturated market, and with Canadian expansion off the table, TGT will need to find a way to drive growth from its U.S. business. We believe the company will increasingly pursue smaller store formats better fit for urban expansion, invest more in e-commerce to protect same-store sales growth, and pursue additional productivity initiatives to free up more cash.
Altogether, TGT seems likely to continue transitioning to more of a mature cash cow that increasingly returns cash to shareholders. Profitable growth in the mass merchandise industry is hard to come by given the market’s saturation, rising labor costs, and increased pressure from e-commerce competitors that benefit from lower operating costs.
The business will continue generating nice profits for years to come, but investors expecting 5-10% annual earnings growth could end up disappointed.
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. TGT’s long-term dividend and fundamental data charts can all be seen by clicking here and support the following analysis.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
TGT recorded a very strong dividend Safety Score of 86, suggesting its current dividend payment is safer than 86% of all other dividend-paying stocks. The company’s moderate payout ratios, consistent cash flow generation, and durable store base support the rating.
Over the last 12 months, TGT’s dividend has consumed just 30% of the company’s free cash flow, providing plenty of support for the dividend and opportunities for future dividend growth. Its forward earnings payout ratio is higher but still less than 50%.
For dividend companies with enough operating history, it’s always a prudent exercise to observe how their businesses performed during the financial crisis. TGT’s sales grew each year during the