Target: Recent Share Price Slump Offers Buying Opportunity In Discount Retailer

The earnings history shows that the Minneapolis headquartered general retailer enjoyed a surge in earnings during COVID, largely attributable to consumers spending more on home goods, Target’s growing success in e-commerce, and the boost to spending from stimulus payments and enhanced unemployment benefits. The consensus earnings outlook suggests that a considerable amount of the growth over the past two years will persist.

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In the earnings call following the Q1 results, management and supply chain constraints, as well as the substantial decline in purchases of home-related goods (specifically citing kitchen appliances, TVs, and outdoor furniture). The company was caught with a substantial oversupply in these types of goods, resulting in costs to store this inventory as well as to shift to focus on items in current high demand.

It is also important to note that TGT’s valuation climbed during the pandemic as consumer spending rose. The P/E was .

The key questions for investors are:

1. How long the inflation-driven spike in costs will persist
2. How much of the earnings growth from the past 2 years will be sustainable

In forming an opinion on TGT, I rely on two forms of consensus outlooks. The first is the Wall Street analyst consensus rating and price target. The second is the , representing the consensus among buyers and sellers of options.

A brief explanation could help readers unfamiliar with the market-implied outlook. The price of an option on a stock reflects the market’s consensus estimate of the probability that the stock price will rise above (call option) or fall below (put option) a specific level (the option strike price) between now and when the option expires. By analyzing the prices of call and putting options at a range of strike prices, all with the same expiration date, it is possible to calculate a probabilistic price forecast that reconciles all of the option prices. This is the market-implied outlook. For more information than is provided here and in the previous link, I recommend published by the CFA Institute.

I have calculated the market-implied outlook to early 2023 and compared this with the current Wall Street analyst consensus, along with considering the fundamentals in assigning a rating for TGT.

E-Trade calculates the Wall Street consensus outlook for TGT based on ratings and price targets from 24 ranked analysts who have published opinions over the past 90 days. Readers may question how relevant any pre-earnings view may be given the recent earnings announcement.

The consensus rating on TGT is bullish, and the consensus 12-month price target is $204, 31.3% above the current share price. All 24 analysts included in this consensus updated or reiterated their views on May 18 and 19. It is notable, however, that none of the analysts used to form the consensus in recent months have had a sell rating on the stock. Following the sell-off, several analysts have suggested that the drop in share price is an overreaction.

Source: E-Trade

Investing.com calculates the Wall Street Research has found that the predictive value of the consensus falls as the dispersion among the price targets increases.

Market-Implied Outlook For TGT/h2

I have calculated the market-implied outlook for TGT for the 7.9-month period from now until Jan. 20, 2023, using the prices of call and put options that expire on this date. I selected this specific expiration date to provide a view through the end of 2022 and because the options that expire in January tend to be among the most traded, adding confidence in the meaningfulness of the outlook.

The standard presentation of the market-implied outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.

Source: Author’s calculations using options quotes from E-Trade

The outlook for January is generally symmetric, with similar probabilities for positive and negative returns of the same size. The expected volatility calculated from this outlook is 40% (annualized), which is high for a large retailer but seems reasonable given the recent massive drop in the share price.

To make it easier to compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).

Source: Author’s calculations using options quotes from E-Trade. The negative return side of the distribution has been rotated about the vertical axis.

This view shows that the probabilities of positive and negative returns are remarkably similar (the solid blue line and the dashed red line are close to one another). However, there is a slightly elevated probability of negative returns for outcomes in the range of +/-15% return over the next 8 months.

Theory indicates that the market-implied outlook is expected to have a negative bias because investors, in aggregate, are risk-averse and thus tend to pay more than the fair value for downside protection (e.g. put options). There is no way to directly measure whether this effect is present, however. Considering the expectation for a negative bias, this outlook is best interpreted as neutral or even slightly bullish.

h2 Summary/h2

The recent slide in Target's share price begs the question of whether the shares have been oversold. The prevailing view among Wall Street analysts is that the selloff is an overreaction and that the shares are now undervalued. The consensus rating is bullish, as it has been for all of the past year, and the consensus 12-month price target is about 35% above the current share price. The market-implied outlook for TGT is neutral to slightly bullish, with expected volatility of 40% (annualized).

As a rule of thumb for a buy rating, I want to see an expected 12-month total return that is at least half the expected annualized volatility. Taking the analyst consensus price target at face value and adding the dividend, TGT is well above this threshold.

That said, none of the analysts anticipated the recent earnings shock as there were no sell ratings just prior to Q1 earnings. Considering the improved (lower) valuation, the bullish Wall Street outlook, and the neutral / slightly bullish market-implied outlook, I am cautiously optimistic, so I am assigning a buy/bullish rating.

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