Contributor C.Cheng says:
“According to Morningstar, ‘increased competition from rivals such as Wal-Mart, Costco, and Amazon is an ongoing threat to Target's share of domestic retail sales.’ Furthermore, Target's expansion into Canada proved to be bumpier than predicted and they will probably not meet their projected targets. What are your concerns regarding these developments?
“Over the course of the past year, Target has reached its 52-week low and is currently hovering near it. Do you think this is a temporary development or an indication of a fundamental issue with the company? (found here)”
Our Response:
The primary concern seems to be how long Target can suffer from bad execution or will the company continue to spiral down. The mention of Wal-Mart (WMT) reminds us of a previous review we did of the stock. On June 8, 2009 (found here), we had the following to say of Wal-Mart:
“The price pattern [not increasing in value] on Wal-Mart reflects a concern by investors, starting in 2000, that the consumer economy was going to be in trouble. If the price goes above $70 or goes below $45 then we'll have some advanced warning about what may be around the corner for the U.S. and Chinese economy. Seems that this company is a leading or more reliable indicator (for the time being).
“In general, Wal-Mart's stock is not being recognized for the simple fact that the company can generate positive earnings. Although WMT's debt really bothers me, company management may be clever like a fox by amassing huge amounts of debt now to be paid off later with inflated dollars.”
Many investors were disappointed about the fact that for nearly 10 years, from 1999 to 2009, Wal-Mart’s stock price traded in a range from $40 to $65. This is an example of the risk that a retailer like Target (TGT) might face, trading in a range for an extended period of time.
However, the premise of the 2009 Wal-Mart article was that if, over an extended period of time, the company can continue to maintain earnings, increase or retain margins, borrow prudently and decrease shares outstanding there is a good chance that value of the company will increase. Not long after the 2009 Wal-Mart article, with the stock trading at $49.84, the shares of WMT broke out of the $65 resistance level and increased to the most recent high of $81.37, an increase of +63%.
Our purpose of tracking stocks that have a history of dividend increases, like Wal-Mart and Target, is to determine values and the competency of management. The decision to increase dividends cannot be sustained over an extended period of time if management is incompetent, perpetuating fraud or willful negligence. When we acquire a stock like Target at depressed levels, we’re indicating that the problems faced by the company, although a current drag on the stock price, will be resolved in due time. Keep in mind that downside risks should always be a consideration.
A secondary concern that is worth addressing is the source of analyst reviews and the quality of such reviews. For example, Deutsche Bank Markets Research provided this analysis of an investment downgrade of Target on July 12, 2013, within 2 weeks of the top ($73.50) in the stock price on July 24, 2013.
Although DB was not in the position to offer a pure sell recommendation, a failing of most research shops, the downgrade with an upside target that was spot-on indicates the high quality of the research that was done. We recommend you get a copy of this report to see what the risks were, according to DB, in advance of the subsequent decline that had ensued.
Contrast the Deutsche Bank downgrade on July 12, 2013 with the Piper Jaffray review on July 9, 2013 which gave Target the highest rating possible of Overweight, essentially a buy recommendation two weeks before the peak.
Piper Jaffray essentially gave a buy recommendation of the Target within 4% of the high. Additionally, the stock was expected to increase to $80. This is a report that is worth contrasting to the DB report. We’d eliminate the points that are similar and focus on the differences as the defining piece to the quality of the analysis, in favor of DB.
A challenge with Morningstar reports is that they have a cookie cutter approach that is easy to identify the weaknesses. Below is an excerpt from the Morningstar Report dated July 8, 2011 when Target was trading at what was later to be revealed the low in the stock price from the January 3, 2011 peak.
Just to highlight what was said by Morningstar, at the time:
“Increased competition from rivals such as Wal-Mart, Costco, and Amazon are ongoing threats to Target's share of domestic retail sales.”
It appears that Morningstar’s overall risk analysis does not change whether at a low in the price or at a high. Because this was a general risk assessment we wouldn’t put much emphasis on this particular warning on the stock. However, the most informative assessment of risk within a Morningstar report is usually the section titled “Bulls Say” and “Bears Say”.
Although normally a good summary of both sides of the matter, the case for and against Target, as made in the Morningstar report dated May 27, 2014 are essentially offsetting points as the “Bull Says” section indicates, “PFresh and REDcard should help to drive store traffic, delivering enough expense leverage to offset the negative impact on gross margins from those initiatives.” While the “Bear Says” section suggests, “Target's ROICs have declined since the PFresh initiative transitioned a larger portion of assets to lower-return food business.” Usually, this section is better at outlining the risks and potential benefits of ownership of the stock. For Target it wasn’t particularly enlightening.
Our own recommendation of Target on June 24, 2011 (found here), at the low, was as follows:
“Target (TGT) landed in the third spot after Fitch cut its debt rating. They’ve taken the rating down from A to A- on claims that Target is aggressively buying back its own shares and remodeling stores in Canada. We’ve said it before that shares of Target look attractive at a 2% yield but it’s even more attractive at a 2.59% yield. This yield boost was because the company raised its dividend by 20%, from $0.25 to $0.30 per share. Once again, IQTrend has estimated that Target is a good buy when it reaches a 1% yield.”
We believe that understanding the downside risks are vital to the success of any investment that is ever made. Additionally, the quality and consistency of such assessments should line up a majority of the time. In the particular case of Target, the risks are still out there, however, we believe that the history of the company’s management team ensures that the problems are being addressed which may include taking the losses by closing the Canadian stores and cutting or leaving the dividend unchanged.