6/10/2010
By Brian Sozzi, Research Analyst

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Whereas Wal-Mart's (WMT) annual shareholder meeting resembled more of a rock concert than a place to conduct vital business, Target (TGT) hit the mark with its comments at its annual shareholder gathering yesterday.  Wal-Mart strolled out Jamie Foxx to emcee its Bentonville-based event, along with a host of other noteworthy Hollywood names, in the hopes of snagging some positive press amidst a spate of negative headlines and maybe even a few new shareholders.  Bluntly, Wal-Mart failed on both accounts.  As I penned earlier in the week ("Why Wal-Mart Blew its Annual Love Affair") Wal-Mart management appeared prouder to be rubbing elbows with Hollywood's finest instead of doing what was necessary to reinvigorate a stock that has been dead money approaching two years.  On the other hand, Target acted like a company that has gotten its financial groove back, which it has by the way.  Although there were surprisingly only three questions from shareholders at the meeting during the portion that was streamed over the internet, Target management lifted the veil on initiatives that certainly support our bullish investment thesis on the stock.  Coming out of the annual events of two of the most recognizable retailers on the planet, places where many spend their entire paychecks, the battle to excite existing shareholders and whet the appetite of potential new shareholders unequivocally went to Target.

What Target Management Tossed onto the Dartboard

* A near 50% increase in the dividend.
* A reiteration of the commitment to aggressively renovate stores to include the P Fresh food format and updated presentations for cosmetics, shoes, electronics, and videogames.
* A slide presentation of the highly integrated Target web business between online, store, and mobile.
* A new 5% reward program for those that utilize Target cards.  Initiative will be accretive to EPS in 2011.  As perspective on the relative strength of this program, Costco's 2% executive membership reward program has been one of the industry benchmarks.
* An initial broad stroke painted regarding 2011 and 2012 new unit growth (it will be accelerated).
* In depth color on "green" initiatives.  While these actions are Mother Earth friendly, the fact is that solar panels on roofs, light sensors, energy management systems, and better packaging of trucks saves costs and boosts EPS.  More shareholders should be asking questions on this topic.

Investment Thesis on Target

With the overall positive indications that have emerged from the business to start 2010 (sales by merchandise category, sales recovery in housing downturn markets, credit card portfolio trends) we believe the stock is attractively valued at a P/E multiple of 11.3x our FY11 EPS estimate of $4.65, a valuation that is near the low-end of the nine-year range (see comparison table below).  In fact, we find it interesting that despite the promising trends arising out of Target, and the potential for plus 15.0% EPS growth in FY10 and FY11, that the stock on the basis of P/E trades in line to Wal-Mart.  As continues to become obvious, Wal-Mart is losing the share it won during the recession (middle-income) and simply as a result of its size will not grow earnings in line to, or above that, of Target medium-term.  Target shares trade at 0.5x forward year sales, the mid-point of a 0.3x to 0.9x nine-year range; again we view the valuation as attractive in front of Target's comp  acceleration trend and new unit growth resuming to a stronger degree in 2011 and 2012.

The aforementioned P Fresh food format, which sports a healthy EBIT margin rate relative to the overall business, is goosing customer traffic and leading to cross-selling.  Thus far, 450 Target stores boast the P Fresh format.  Approximately 40% of Target's business (apparel/accessories and home furnishings) counties to reawaken, and given the efforts around better sourcing the products, suggest margin traction.  Furthermore, Target's store productivity continues to be a good story, one that is overlooked by many in our view. 

How to Interpret the Relative Comparisons

* For a cheaper relative P/E multiple, investors receive a higher growth opportunity in Target, derived from a more discretionary merchandise assortment and the management of a receivables portfolio which enhance the EBITDA margin structure (observe expected earnings growth rates for each company in 2010 and 2011).

* For a roughly comparable P/S multiple, investors receive a company displaying greater comparable store sales traction and reduced exposure to currency risk (Target is a U.S. operation, Wal-Mart global).

Brian Sozzi
Wall Street Strategies