In this video, we perform a deep dive on Target’s dividend safety.
To begin, let’s talk about Target’s business model. Target is one of the largest retailers in the United States. The company was founded in 1902 and today, its business consists of 1,850 discount stores which offer both general merchandise and food. Target trades with a market capitalization of $37 billion.
Target is a well-known dividend stock because of its compelling track record of dividend growth. With 50 years of consecutive dividend increases, Target is a member of the Dividend Aristocrats, a group of dividend stocks with more than 25 years of rising dividends. You can download our free list of Dividend Aristocrats here: https://www.suredividend.com/dividend-aristocrats-list/
Target’s dividend history satisfies the requirement to be a Dividend Aristocrat more than twice over. Because of this, Target is not just a Dividend Aristocrat but also a Dividend King, a group of even more exclusive stocks with 50+ years of dividend growth. You can download our free list of Dividend Kings here: https://www.suredividend.com/dividend-kings/
Looking ahead, the potential effect of ecommerce competition has led some investors to question the safety of Target’s dividend. For the remainder of this video, we will discuss the company’s current dividend safety from four perspectives: it’s dividend safety in the context of its current earnings, its dividend safety in the context of its current free cash flow, its dividend safety in the context of its recession performance, and its dividend safety in the context of its current debt load.
Target’s Dividend Safety Relative to Earnings
When Target reported third quarter financial results on November 20th, the company reaffirmed its financial guidance for the full fiscal year. Target continues to expect to generate adjusted earnings-per-share between $5.30 and $5.50 for the twelve-month reporting period.
For context, Target currently pays a quarterly dividend of $0.64 per share, which implies a full-year dividend payout ratio of 47% using the midpoint of the company’s current financial guidance.
Target’s Dividend Safety Relative to Free Cash Flow
Through the first nine months of fiscal 2018, Target generated $3.6 billion of cash from operating activities and spent $2.9 billion on capital expenditures for free cash flow of around $700 million. At the same time, Target spent around $1 billion on dividend payments. This implies a free cash flow payout ratio of 133% - which is clearly unsustainable over long periods of time.
With that said, Target’s year-to-date results were simultaneously impacted by a large increase in its inventory account (which reduces cash flow from operating activities) as well as higher-than-normal capital expenditures. The cyclicality of Target’s operations around the holiday season means that looking at full-year financial results is a much better way to assess its dividend safety.
Accordingly, we can turn to Target’s 2017 results. Through the full fiscal year, Target generated $6.9 billion in cash from operating activities and spent $2.5 billion on capital expenditures for free cash flow of about $4.4 billion. At the same time, Target paid $1.3 billion of dividends for a free cash flow dividend payout ratio of 57%.
On the surface, Target’s dividend safety relative to free cash flow appears alarming if we assess only its year-to-date financial results. However, measuring its dividend safety over a longer time horizon reveals that Target’s dividend is safe for the foreseeable future.
Target’s Dividend Safety Relative to Recession Performance
We believe that the best way to measure a company’s recession resiliency is by measuring its earnings-per-share performance during the financial crisis that occurred between 2007 and 2009. Target’s performance during this time period is shown below:
• 2007 adjusted earnings-per-share: $3.33
• 2008 adjusted earnings-per-share: $2.86
• 2009 adjusted earnings-per-share: $3.30
• 2010 adjusted earnings-per-share: $3.88 (new high)
Target performed very well during the last recession. Although earnings declined slightly, they rebounded to a new high in 2010. Accordingly, we have no concerns about the company’s ability to pay rising dividends moving forward.
Target’s Dividend Safety Relative to Its Current Debt Load
In Target’s 2017 10-K filed with the Securities and Exchange Commission, the company reported a weighted average interest rate of 4.1% on its outstanding debt of $10.4 billion. This implies aggregate interest expense of $426 million.
As the image in our video shows, Target’s weighted average interest rate would need to increase above the 25% level before its interest expense would reduce its free cash flow enough to endanger its dividend. Accordingly, we believe that Target’s debt level is unlikely to impact the safety of its dividend moving forward.