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Target: Beaten Up But Still Kicking

The internet changed everything. Nowhere is this more apparent than the retail industry.Target-earnings

Internet retailers, led by Amazon.com (NASDAQ: AMZN), are destroying everything in their paths. Retailers that maintain a physical presence are getting hit hard; many cannot compete with the low prices and convenience of at-home shopping that internet retail shopping provides.

Stock prices across the retail industry are collapsing. The latest victim was Target (NYSE: TGT).  The Target share price crashed 10% after the company gutted its earnings guidance for 2017 last month.

This is a very challenging time to be a big-box retailer. But while things certainly look grim, those counting Target out may be proven wrong over the long-term.

Missing the Target

On Feb. 28, Target announced fourth-quarter and full-year financial results that missed expectations. Fourth-quarter comparable sales is a key measure for retailers that calculates growth at locations open for at least one year.

Even worse, Target made a huge reduction to its 2017 forecast. The company now expects comparable sales to decline at a low-single digit pace, and earnings per share are expected to decline 20% at the midpoint of its 2017 forecast.

In addition, Target will compete more aggressively on price, and continue to invest in its online presence. These are clear indications that it is finally taking Amazon.com head-on.

This will surely be a costly investment process, which explains Target’s huge guidance cut.

The share price reaction has been swift and severe: Target shares were trading above $70 at the start of 2017; now, it’s a $55 stock.

Investors are not waiting around for Target’s turnaround to materialize. While this short-term thinking is nothing new for the stock market, long-term investors are given a buying opportunity.

Still Highly Profitable

Target is struggling to adapt to the new retail environment. But it’s not alone in that sense. And, Target has key advantages that should help its turnaround succeed.

Specifically, Target has a nationwide footprint, brand recognition, and scale.

While earnings are set to decline, the company remains highly profitable. Target generated an after-tax return on invested capital of 15% last year.

This is a strong return on capital, especially during a very difficult time for retailers, and shows the cash-generating ability of Target’s business model.

Target’s investments in e-commerce should not be viewed as a bad thing. While margins are low, retailers need to keep up, otherwise Amazon.com will keep gaining share.

Target’s digital channel sales have doubled in the past three years, indicating that its e-commerce platform can work.

Next, Target will be reducing its square footage. This is another step in the right direction. The old retail model of big-box stores and “super centers” is a thing of the past, particularly when it comes to densely-populated urban areas.

Target is busily expanding its group of small stores, which are called CityTarget and TargetExpress. By 2019, Target expects to more than triple its small-store count. This investment will help open up millions of new potential customers for Target, that it couldn’t effectively reach before.

Target Shares: Compelling Value

Now that Target shares have been beaten down, the upside going forward is that expectations are very low.

Target shares trade for a P/E of 10, which is near a multi-year low for the stock. And, because of its plunging stock price, the dividend yield has been elevated to 4.3%.

With such a low valuation multiple and a high dividend yield, investors could earn strong returns, even if the company simply treads water.

Target’s 2017 forecast still calls for earnings of $4 per share, which will easily cover its dividend. Target has made nearly 200 quarterly dividend payments without interruption, going all the way back to its IPO.

And, with 45 years of consecutive dividend hikes under its belt, Target is a proven dividend growth stock.

As a result, the pervasive pessimism has created a low hurdle to clear for the company. Things are scary in retail right now, but Target shares are on deep discount and they are a bargain.

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