Low valuation and less pressure on margins
On May 20, Morgan Stanley upgraded Target (TGT) to “equal-weight” from “underweight.” Target’s low valuation and expected moderation in margin pressure led Morgan Stanley to upgrade the stock.
We expect Target’s profit margins to remain subdued, which reflects higher digital fulfillment costs led by growth in digital sales. Higher wages and investments in growth initiatives will likely weigh on the company’s margins. However, pressure on the margins is expected to ease due to the company’s focus on reducing the per unit digital fulfillment costs and better e-commerce margins. Walmart (WMT), which reported its first-quarter results on May 16, benefited from higher margins in its digital business and a favorable mix.
On the valuation front, the recent pullback in Target stock makes it inexpensive on the valuation front. Target stock trades at 12.3x its expected fiscal 2019 EPS of $5.84. Target’s bottom line is expected to mark high single-digit growth in fiscal 2019 due to continued growth in comps, lower interest expenses, and share repurchases. Target offers a dividend yield of 3.3%.
In comparison, Walmart and Costco (COST) stock trade at a forward PE ratios of 20.8x and 30.6x, respectively.
Most of the analysts recommended a “hold” on Target stock due to pressure on its margins. Among the 26 analysts, 16 recommended a “hold,” while ten recommended a “buy.” Analysts have a consensus target price of $86.6 per share on Target, which implies an upside potential of 20.1% based on its closing price of $72.08 on May 21.