For years the Minneapolis-based discounter used a mix of low prices and playful style to make big-box bargain shopping cool. That allowed “Tarjay” to hold its own against the 800-pound gorilla, Wal-Mart.
Lately, though, the chain finds itself in a struggle. Target may have bitten off more than it can chew by following Wal-Mart into the slow-growing, low-margin grocery business. Meanwhile, competition from cheaper, cooler online players like Amazon.com is heating up. Some investors, though, think the retailer’s stock itself is now looking like a bargain.
A tougher price war
Just as Wal-Mart and Target disrupted Main Street retailers two decades ago, Amazon is now threatening these two discounters. The competition is likely to hit Target harder. William Blair analyst Mark Miller compared prices at all three places and found that, where Amazon’s offerings overlapped, the online giant undercut Target more than it did Wal-Mart.
There’s also the cool factor. Amazon’s brand is built around being cutting-edge and cheap, which overlaps directly with Target’s cheap-chic message. To drive more sales, Amazon is turning to Kindle tablets and streaming video. Target, for its part, is relying on, um, groceries. “Target has lost momentum,” says Miller. “Amazon changed the game.”
Facing challenges abroad
Groceries, which now account for a fifth of Target’s $73 billion in sales, were a calculated risk to drive more foot traffic. The result thus far: lower profitability. Morningstar forecasts that Target’s return on invested capital over the next five years will slip from 12.7% to 10.5%.
Where can the company turn to find more growth? Unlike Wal-Mart, with more than 6,000 stores abroad, Target has largely been U.S.-centric. Management hopes a plan to open more than 120 stores in Canada by year-end will change that.
So far, not so good. Weaker-than-expected sales and losses up north have knocked about 13% from Target’s share price since July. “They underestimated the competition,” argues William Blair’s Miller.
Pumping up payouts
Target may not be the sexy growth stock it once was, but the company’s shares are still coveted by value-minded investors, says Drew Weitz, analyst at Weitz Investments, whose mutual funds own the stock.
Target is already yielding more than the broad market, but the gap should widen after a 19% dividend increase set to boost the stock’s yield to 2.7%. What’s more, thanks to about $1.5 billion in share buybacks this year, the company has managed to raise its earnings per share even as profit margins have narrowed.
There’s also the fact that starting next year, Target won’t be spending as much to build out its business in Canada. “We’re expecting a healthy amount of cash to come back to shareholders,” Weitz says.