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What a brutal six months it’s been for Target. The stock has dropped 36.1% and now trades at $95.70, rattling many shareholders. This may have investors wondering how to approach the situation.
Is there a buying opportunity in Target, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Is Target Not Exciting?
Despite the more favorable entry price, we don't have much confidence in Target. Here are three reasons why we avoid TGT and a stock we'd rather own.
1. Shrinking Same-Store Sales Indicate Waning Demand
Same-store sales is an industry measure of whether revenue is growing at existing stores, and it is driven by customer visits (often called traffic) and the average spending per customer (ticket).
Target’s demand has been shrinking over the last two years as its same-store sales have averaged 1.8% annual declines.
2. Low Gross Margin Reveals Weak Structural Profitability
Gross profit margins are an important measure of a retailer’s pricing power, product differentiation, and negotiating leverage.
Target has bad unit economics for a retailer, signaling it operates in a competitive market and lacks pricing power because its inventory is sold in many places. As you can see below, it averaged a 28% gross margin over the last two years. Said differently, Target had to pay a chunky $72.05 to its suppliers for every $100 in revenue.
3. Weak Operating Margin Could Cause Trouble
Operating margin is an important measure of profitability for retailers as it accounts for all expenses necessary to run a store, including wages, inventory, rent, advertising, and other administrative costs.
Target was profitable over the last two years but held back by its large cost base. Its average operating margin of 5.3% was weak for a consumer retail business. This result isn’t too surprising given its low gross margin as a starting point.
Final Judgment
Target isn’t a terrible business, but it doesn’t pass our quality test. Following the recent decline, the stock trades at 10.2× forward P/E (or $95.70 per share). This valuation is reasonable, but the company’s shakier fundamentals present too much downside risk. We're fairly confident there are better investments elsewhere. We’d recommend looking at one of our all-time favorite software stocks.
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