Target (NYSE: TGT) has found a way to thrive in a brutally competitive industry. The retailer's fashionable products and national network of locations helped it produce strong earnings growth over the past few decades as demand for general merchandise expanded with a growing population. Those profit gains have, in turn, translated into consistently rising dividends for shareholders.
That formula isn't looking as robust these days as Target wraps up what could be its second straight year of flat or declining sales. With that challenging selling environment in mind, let's look at the prospects for this retailer's dividend.
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Long track record
Target hasn't missed an annual payout raise since the company went public in 1967. That half-century streak easily qualifies it as a Dividend Aristocrat and makes Target one of just a few retailers to earn that title.
Not only has Target's dividend survived several recessions and multiple periods of dislocation in the industry, but it also held up through major self-inflicted financial wounds. The company's failed expansion into Canada, for example, led to a $1.6 billion loss in 2014. Yet management prioritized dividend growth even through that period, hiking the payout by 11% between 2014 and 2015.
That stellar track record adds heft to management's dividend commitment. When executives say, as they do in the 10-K report, that "we maintain a competitive quarterly dividend and seek to grow it annually," investors know just how seriously Target takes that promise to hike its payout each year.
Healthy payout ratio
Last year's dividend payment was just over $1.3 billion, or a bit less than half of the $2.7 billion that Target generated in net income. Thus, its payout ratio sits at a comfortable level that's consistent with that of the broader market and of its chief rival, Wal-Mart (NYSE: WMT), which also pays shareholders around 50% of earnings as dividends.
Target's payout ratio has crept higher so far in 2017, rising to 55% of earnings over the first three quarters of the year. A few factors have gone into that change, but the main driver has been decreasing earnings. The retailer is committed to protecting market share even if it means sacrificing profitability, and it has taken that trade lately. Net profits are down 4.5% this year as gross profit margin ticked down to 30.1% of sales from 30.4%
Still, Target makes a disproportionate amount of its earnings in the holiday quarter and so, assuming a steady pace of discounting, the retailer is likely to finish the year with its dividend well protected by profits yet again.
The scale of future dividend hikes will depend on Target's ability to fend off rivals that are focused on stealing its market share. That competition includes traditional retailing giants such as Wal-Mart in addition to e-commerce specialists like Amazon.com.
Target's growth initiatives today include a mix of lower prices and higher investments into its stores and its digital distribution channel. They've so far produced encouraging results, as customer traffic is up 0.9% so far this year compared to a 1% decrease in the prior-year period. Target's e-commerce sales have risen to 4.3% of the business today, up from 3.5% a year ago.
Yet despite these gains the company has predicted flat, or just slightly higher, revenue over the critical holiday shopping season. That downbeat forecast confirms that Target's growth challenges are likely to extend into a third consecutive year in fiscal 2018, even if its dividend -- and the unusually high 4.5% yield -- is in no danger of being cut anytime soon.
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