Investors have punished many retailing stocks lately on worries about the loss of profit power as e-commerce shopping gobbles up more of the broader retailing pie. Target (NYSE: TGT) has been no exception. Shares have barely budged over the past five years even as the S&P 500 has gained over 60%.
Sure, the retailer's profit picture seems cloudy today. But there are good reasons for investors to be optimistic about the stock going forward. Below, we'll cover three of the biggest causes for optimism about this unloved retailing stock.
Healthy customer traffic
Back in February of 2017, after a brutal holiday shopping season, Target announced a shift in its strategy that, among other goals, sought to return the company to healthier customer traffic trends. That metric declined 1% for the full 2016 fiscal year, leading to a slight drop in overall sales, and executives weren't looking to repeat that painful performance.
Trends have improved dramatically on this score. Customer traffic jumped 3% in the most recent holiday period, in fact, which pushed overall transactions higher by 1.6% for the year.
Target's 2018 is looking even better. Traffic soared by 3.7% in the fiscal first quarter, trouncing rival Walmart's (NYSE: WMT) 0.8% uptick. Its latest result also marked the retailer's strongest performance on that metric in over 10 years. Meanwhile, CEO Brian Cornell said in late May that this positive momentum accelerated into Target's fiscal second quarter, so investors should expect to see more gains ahead in this fundamental growth trend.
The bad news for the business is that Target is paying a steep price to win back that lost market share. Its gross profit margin recently dipped below 29% of sales as it cuts prices. And rising expenses, tied to store remodels and the aggressive buildup of its e-commerce infrastructure, are having an even bigger impact on profitability. Together, these negative trends pushed adjusted profit margin down to 6% of sales last year from 7% in each of the past two fiscal years.
Executives have warned investors to expect 2018 to be another rebuilding year, but margins shouldn't shrink by as much as they did in 2017. Looking further out, the plan is to stabilize profitability at a healthy level. "We don't believe margin rates are going to unsustainably low levels," Cornell explained back in March. Its more recent earnings report added weight to that prediction as Target affirmed its full-year outlook for adjusted earnings.
Target's stock isn't reflecting much enthusiasm on the part of investors. It is valued at 14 times trailing earnings, or a bit less than the P/E ratio of 16 it has reached at times over the last year. Shares have completely sat out the latest stock market rally and are down 7% since mid-2015 compared to a 35% increase in the S&P 500 and a 20% spike for Walmart.
That pessimism might be fertile ground for a share price rebound, assuming the next few quarters play out as management is hoping they will. Having solved their biggest growth problem, Target might be able to focus a bit more on maximizing profitability in the upcoming holiday shopping season. Even a slightly positive surprise in this area could cause investors to reassess their downbeat forecasts for this retailer, who, after all, is making positive strides toward thriving in the new multichannel selling environment.
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