Target: Pre-Earnings Buy Signals – Target Corporation (NYSE:TGT)


I last recommended Target (TGT) when it was trading in the low $50s. It is now more than double that price. I was recently asked whether TGT is still worth a buy.

Worth Buying In General?

Besides having a strong dividend history and high dividend yield relative to its industry, TGT also excels at returning capital to shareholders via buybacks. While the defensive retail sector has an average share buyback ratio of zero over the past three years, TGT’s buyback ratio is nearly five.

The company is quite profitable, in spite of what the bad news in the past couple months regarding falling holiday sales might imply. Several of its important profitability metrics, including return on equity, return on assets, and net margin (income over revenue), are in the top quintile of its industry. Importantly, EPS is on the rise, and analyst estimates expect the uptrend to hold. With earnings coming up in March, this is one value to keep an eye on, as EPS is correlated with TGT stock price:

(Source: Simply Wall St)

Relative to the rest of its industry, TGT offers one of the best EPS growth trends. Other comparisons, too, show the company to be a rare balance of value and the return of shareholder capital:

(Source: Stock Rover)

As for that dividend, it is safe and stable. Currently, the dividend is covered by earnings, with only a 41% payout rate. If earnings and dividends increases continue on their current track, the payout rate will become even lower over the years, helping TGT maintain its status as a safe dividend growth investment.

Still Worth Buying at this Price? Entry Point Talk

The first thing to note is that the stock is still fairly valued by many of my measures, especially when compared to the consumer defensive discount store industry:

TGT

Industry

EBITDA/EV

0.098

0.079

Price/FCF

17.8

27.4

Price/Earnings

19

41

Price/Tangible book

5.2

20.7

(Source: Damon Verial; data from Tiingo)

We should remember that it is not the price of a stock that matters, but whether it will be trading at a higher price in the future. Fair valuations, especially against the industry that contains the stock, support the idea that a stock is not overpriced – i.e., we don’t have the irrational buying to create an unsupported bubble.

Notably, February is one of the best times to buy TGT:

(Source: Damon Verial; data from Tiingo)

From February to March, TGT has yielded an average return of over 5%. You could play this seasonally, exiting for April-May, and re-entering in June if you like to time the market. Even if you don’t, the above chart can be useful for buy-and-holders, giving you two strong dollar cost-averaging entry points (February and June).

Entering now also gives you access to the upcoming dividend (ex-dividend date is Feb18). Based on TGT’s dividend pattern, the company should be raising its dividend soon:

(Source: Stock Rover)

If you want to drill down even further, you can find the best entry time to be on down area gaps. These often occur in the morning, at market open. For TGT, the probability of such a gap filling within the day is roughly two-thirds and gives you an expected return of 56 cents per share. You can think of entering on a down gap as a discount on your holding; with the average down gap being of size $1.33, this is a decent discount.

Ideas for Earnings

So, your eyes should be on earnings. TGT reports next month, and the recent news of lower comps, expectations and sentiment are down. This is good, as an earnings surprise can easily reverse expectations and sentiment, leading to higher price targets.

And the company has a good track record of surprising on earnings:

(Source: Stock Rover)

This makes this year’s February an even better entry point. Of course, when playing earnings, we wish to hedge our downside risk. The best way to do this is via options.

A simple options strategy is to simply buy calls before earnings. I like the Mar13 $118 calls. If you want something more complex, with better downside protection, consider the following strategy:

  1. Buy 1x Mar13 $105 call
  2. Sell 5x Mar13 $122 calls

This strategy reduces risk by giving you an upfront payment for opening the position. You will profit no matter what, provided TGT closes below $123 by Mar13. The maximum profit is achieved when TGT closes at $122 by Mar13.

The main disadvantage here versus the long call is that you have limited upside profit potential. Of course, you can move the strike price of the short calls upward to increase your upward profit potential in exchange for less initial credit. In addition, if you cannot sell calls in your account, this strategy is outside of your toolbox.

Risks

Going long on TGT is not without risks, of course. One general risk is related to the company’s dividend yield, which is lower than its historical average. A low historical dividend yield is an obstruction to buying and position-adding, as dividend investors feel they are buying in at a worse point than before.

Many dividend stocks find strong support levels when dividend yields are lower than their historical averages, as investors want to “lock in” a high yield. This means TGT will have problems finding a floor if it falls. And market risk – perhaps the biggest risk to TGT – makes a fall possible (especially considering the COVID-19 affair), dragging down the stock regardless of the strength of the company itself.

Amazon (AMZN), of course, is always a risk to Target. Amazon’s constant downward pressure on shipping prices and duration continue to make it a strong alternative to the physically oriented Target. Target’s strong point over Amazon has always been convenience and ever presence, but as Amazon enhances the convenience of online buying, the incentive to shop at Target decreases. Still, Target has fared well over the years despite analysts claiming Amazon would be the downfall of Target. We have not yet seen Target enter a phase of redundancy, but the possibility is always there, especially as Amazon ups its game. Be sure to watch Target’s foray into digital, which is currently slow, going forward.

Finally, the falling holiday sales could show a reversal in consumer spending – a large risk to TGT, but a mostly unpredictable one. You can easily hedge this risk via a pair trade. For example, go short on consumer staples, such as via the consumer stables select ETF (XLP), while being long on TGT; this hedges industry risk.

As for the options strategy, above, you have lower downside risk than you would with a pure bull call spread due to opening the position at a net credit, but you “gain” an upside risk if TGT rallies too quickly. Maximum loss here is unlimited but does require a significant surge in the stock before Mar13. As long as you have a clear price target for TGT, you can manage this risk (by placing the strikes of the short calls at that price target).

Give the option strategy a shot, and let me know how it goes.

Happy trading!

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.





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