Target (TGT): A Company Valuation

?(Disclaimer: Excel file attached below the post)?

Target is without a doubt one of the few national brands that come to mind when thinking about resilience, expansion, advancement, and operational efficiency in a post-pandemic unpredictable environment. I have come across more Target stores in NY in the last two years than I have in the last 20 years. Why is that? Just a few days ago, I overheard a conversation amongst a group of people talking about a new Target store opening in their neighborhood and how "It would make their lives so easy!" It goes without saying, that given my passion for company valuations, I had a new target (yes, pun intended) in my sight. Here are my not so expert thoughts about the company, its past (especially during and post pandemic), and its future. Enjoy!

Target: TGT

Target was incorporated in Minnesota in 1902, and ever since its inception, it has very expertly, and sometimes not so expertly, woven itself into the American cultural, social and economic fabrics. Its long history speaks volumes about not only its resistance, but also its perseverance through muddy times such as the LGBTQ+ backlash, consumer data usage to the boycotts rooting from the company's policies surrounding bathrooms. Over the decades of its existence, the company has grown through both organic and inorganic methods resulting in one of the major players in the modern retail industry.?

The overwhelming consensus over the past decade or so has been that brick and mortar retail industry will be replaced with online shopping and companies will have to yield and make way for the future, but not Target; the company has not only welcomed and tackled technological advancements and changes in consumer preferences through investments in new technology, but has also religiously stayed true to its physical presence by opening 200 new stores in the last few years and expanding its presence across the country; one of the reasons you might be seeing more and more Target stores erected of late as well as remodeled and updated locations. Below is a list of Target's number of stores across all states as of this post:

2023 Operational Highlights

Before we can talk about the future and the company's goals and strategies for future growth and sales, I think it is prudent for us to talk about the base year and how the company has weathered the latest trends in the markets and changes in consumers' behavior over the last year.?

The company reported total revenues (comprised of sales and other revenues) of $107B for the FY '23, which were 1.6% ($1.7B) lower than the previous year's reported total revenues of $109B. The decrease of 1.6% in total revenues reflects a decline of 1.7% in sales and a corresponding increase of 5.1% in other revenues. Company also reported an operating income of $5.7B, which was a 48.3% growth over the last year's purported number of $3.8B. Additionally, the company reported EBITDA of $8.5B, a growth of 29.9% over the last year's reported number of $6.5B as well as GAAP and adjusted diluted earnings per share of $8.94. Moreover, company reported operating cash flows of $8.6B (an increase of 114.6% YOY) due to higher net earnings and improvement of working capital items especially lower level of inventories. Company had $11.9B worth of inventory by the end of the year, a decrease from $13.5B reported for FY '22. The decrease in inventory levels was mainly driven by better supply chain management, aligning inventory levels with sales trends and lower freight costs in FY '23.?

Target reported gross profit margins of 26.5%, higher than 23.6% the company reported by the end of FY '22. The increase in gross profit margin was driven by lower costs due to efficient inventory management, lower costs related to freight and supply centers, and lower promotional markdown rates and other costs compared to last year.?

It is evident from rummaging through the company's latest 10K that sales declined in FY '23 in line with the general retail industry. In particular, the company suffered lower growth in its discretionary categories (apparel & accessories, hardlines, home furnishings and decor) which was offset by growth in its frequency categories (beauty & household essentials and food & beverage). The decrease in discretionary categories started during and due to the pandemic and as a result, management deployed strategies to ensure that the company's inventory was efficiently managed and that stores weren't carrying excess levels of inventory; an effort that, I must say, has paid in full this year as evident by the company's increase in operating cash flows and gross profit margins.??

Future: Different and Better

As I was getting ready for this valuation and post, I decided to listen to the company's investors' presentation for FY '23, and here are the highlights in terms of what the management has planned and how they intend to move forward.?

• Store Growth: Over the course of the last year, Target invested in over 1,200 locations nation-wide through remodels and partnerships, as a result, the company's store footprint has expanded roughly to cover the entire US. Going off of the increase the management saw in revenues and bottom line as a result of aggressive expansion, the company intends to open 300 new mostly full-size stores and make billions in incremental growth over the next decade.
• Supply Chain and Distribution Centers: Part of the reason why the company's numbers came in rosier than expected was due to the efficient inventory management as well as continued investment in distribution and sortation centers. Target has at least 10 additional supply chain facilities in the pipeline that should be effective over the next 10 years.?
• Investment in Technology: One of the pillars of the company's success over the years has been due to its investment in technology. The management plans to continue on investing in latest and modern technology which includes leading team of engineers, data scientists, and product managers solely focused on enhancing company's competitive position through the use of latest technology such as generative AI (latest buzzword found in all 10Ks and Qs) and machine learning; it seems that the management realizes that the continued innovation and better integration and experience are the keys to the kingdom.?
• Partnerships: Company's partnerships with Starbucks, Disney, Apply, CVS, Levi's, and Ulta Beauty have played a great role in the company's success over the course of the last decade, and management intends to not only improve its current partnerships but also expand over the next decade to include not only companies, but also individual content creators and celebrities such as Ashley Tisdale and Kourtney Kardashian.??
• Owned Brands: Over the years, the company has also invested heavily in its owned brands and their continued success through innovation and differentiation, and the management does not plan to slow down anytime soon. Company plans to launch new brands and expand its portfolio over the course of the next decade through innovation and successful partnerships with nationally and internationally acclaimed brands and designers such as Diane von Furstenberg.?
• Human Capital and Development: Another area the company is invested in are its people and their continued development and success. Over the last decade, the company has taken leadership position in both pay and benefits as well as learning and development of its employees and intends to continually invest in its people so that they have the best training and tools available to them in order to make the company's guests feel comfortable and loved.?

Valuation

Before valuing a company, I think that it is prudent for the person to understand exactly where the company lies in its corporate lifecycle, and as I think about Target and its future, one thing stands out above all: the company's days of double digit growth are in the rearview mirror. I further believe that as the company moves forward in the coming years, the incremental growth in revenues coupled with an even better handle of costs such as COGS, Capex, and SG&A should further improve and stabilize its operating margins. I also believe that the future growth will not entirely be driven by intrinsic factors and aggressive physical expansion, but the company will also have to look at inorganic growth activities as well. With all this in mind, here are my base-case assumptions for the valuation:

• Revenue Growth: This perhaps is the most complicated valuation factor to think about when valuing a retail company because the success of the retail company is more related to the macro environment and changes in consumers' behaviors than any other type of corporation. Target reported a YOY growth of 3.7% in its total revenues for FY '20, and then massive 19% and 13.3% growth rates for FYs '21 and '22, respectively. I believe that the growth in revenues for FYs '21 and '22 was driven off of the fact that people had accumulated capital through pandemic stimulus, and therefore, had more discretionary income to spend; as a result, target realized double digit growth for the said two years. But, over the last year or so, consumers have spent and almost wiped their pandemic savings and are now mainly making purchases through their employment checks, which for obvious reasons, limits their ability for discretionary spending. I expect this trend to continue for the next couple of years as I believe that Target will slowly grow its revenues from -1.6% in FY '23 to 7% by the end of FY 29; I believe this gradual increase will be due to its strong brand name, its continued partnerships with acclaimed brands as well as continued investment in new stores and improvement of its operations in terms inventory and supply chain management. Furthermore, as the company moves past FY '29, I expect revenue growth to taper off and be in line with pre-pandemic levels, so around 4% by the end of the projection period in FY '34.?
• Operating Income and Margins: Despite its peaks and troughs, the company has always reported consistent operating margins, and I expect this trend to continue and improve over the next five years. As the company grows its revenues and improves its operations and costs, I expect operating margins to increase from 5.3% in FY '23 to 7% by the end of FY '29. As the company moves past the mid-projection mark, I expect operating margins to gradually decrease to 5% by FY '34 due to low top line growth and somewhat consistent costs.?
• Costs: I expect costs such as COGS and SG&A to be lower for the next couple of years and then gradually increase as the total revenues increase. I expect that over the next decade, these costs will be lower compared to the base year and I expect this reduction to be mainly driven by a better supply chain management system as well as a better handle on its human capital.??
• Taxes: Company reported a pre-tax income of $5.3B and provisions for taxes in the amount of $1.16B, giving me an effective tax rate of 21.9% for FY '23. Over the next decade, I expect this tax rate to gradually increase to align with the marginal tax rate of 25%.?
• Capex and D&A: Company reported capex of $4.8B (4.5% of total revenue) for FY '23 and this number includes existing store investments, new stores, supply chain, and information technology and other. I expect that the company will grow at 7% by the end of FY '29 and then by 4% by the end of the projection period, and that growth in top line has to come from somewhere and so I expect capex margins to be somewhat in line with the historicals: 5% of total revenues by the end of FY '34. Moreover, as the company invests in capex for the next decade, I expect its D&A expense to increase as well. I expect D&A to be around 90% of capex by the end of FY '34. I will not make capex and D&A a one-for-one connection because I have assumed a perpetuity growth rate of 2%, and growth comes from continued investment, and if I were to assume that by the end of the projection period the company will only be investing enough to replace its existing capex then I am in effect assuming a 0% growth in perpetuity, not 2% like my model is predicting.?
• Net Working Capital: Company reported NWC margins of -4.2%, and given that the NWC consists of a number of items that are hard to predict, I am not assuming too much change for conservatism's sake, and think that NWC margins will be around 5% by the end of FY '34.
• WACC: The risk free rate as of this post is 4.30%, Target's beta is 1.17, and the market risk premium is 3.97%, giving us a cost of equity of 8.95%. I do not have access to third party platforms and so I do not know what the yield is on the latest debt raised by the company, but I was able to gather debt and commercial paper related information in the footnotes; Target issued $500 million at 4.40% interest rate in 2023, and so I am treating that as my pre-tax cost of debt, and assuming a marginal tax rate of 25%, I get an after-tax cost of debt of 3.30%. With the company's 81.6% weight of equity and 18.4% weight of debt, I get a WACC of 7.91%.
• EBITDA Multiple: As I have said at ad nauseam at this point, I do not believe in EBITDA multiple being a part of an intrinsic valuation, but it seems to be an enticing idiom that everyone on the street seems to think is of paramount importance, as such, I have only recently started utilizing it in my own work. I do not know the multiple Target is trading at due to my limited resources, but I can finesse my way into deriving one with the information I do have; my implied EBITDA multiple given my growth in perpetuity of 2% and WACC of 7.91% is 6.40x, and for conservatism's sake, I will assume an exit EBITDA multiple of 6x.?

With all of my assumptions in line, here is my valuation for Target:

In case it isn't legible, I get an implied value per share of $139.59 through perpetuity approach, and $131.36 assuming my exit EBITDA multiple of 6%, in my base case. I also got a price per share of $212.19 in my best case, and $84.12 in my weak case scenario. Target, at the time of this valuation, is trading at $147.60 per share, yielding a MOE of 5.4% for my base case. In the grand scheme of things, I believe that the percentage difference in the DCF derived value and the actual price that it is trading at is negligible and so I would say that Target is trading at an appropriate price, and I would be adding it to my portfolio for stability and risk aversion reasons.?

Sensitivity

Valuation is a very much individual task, and by that I mean that very rarely are two valuations the same, and so to give credence to our analysis, we typically try to make sense and justify our number through data tables and sensitivity analyses. Since DCF is very prone to assumptions, I have decide to analyze and sensitize the implied price per share for varying degrees of WACC, long-term growth rate, terminal year EBITDA multiple, and revenues and margins in the terminal year. Here is what that analysis looks like:

Images 1 and 2 show us the range of price per share given the changes in WACC, long-term growth rate, and terminal year EBITDA multiple. Speaking about image 1, we can clearly see that if I assume a WACC that is lower than my WACC of 7.91%, say 7.41% for argument's sake, and with the same perpetuity growth rate of 2%, I get a price per share of $155.95. If I assume that my calculated WACC is correct, but that the company will grow at a 3% in perpetuity instead of 2%, I get a price per share of $161.82. Similarly, image 2 gives us an idea as to how much the price per share might change given the intricacies of terminal year EBITDA multiple. For my analysis, I assumed an exit EBITDA multiple of 6x, but lets say that it is 8x and not 6x, in that case I get a price per share of $163.06. Lets look at another set of data tables to see if we can make sense of the price Target is currently trading at.?

According to image 3, for the price the company is currently trading at, it would need to earn total revenues of around $170B with operating margins of 5% in FY '34, a feat that I think is unattainable for the company. Image 4 above showcases the impact changes in WACC and terminal year EBITDA would have on the company's implied value per share.

After Thoughts

Company valuations are extremely prone to assumptions and individual biases. Is Target trading at its fair market value? With my understanding of the business, having gone through the investors' presentation, and having rummaged through its 10K, I would say yes, it is fairly valued. Should you agree with my analysis? No, I think that if you are curious, you should download the excel sheet linked below this post and input the numbers that make sense for you.?

Links:

Target Valuation- 07/15/2024

Target- 2024 10K