A Quality Exec Comp Plan Lowers The Risk Of Investing In Target

One new stock makes June’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of June 16, 2021.

Recap From May’s Picks

The Exec Comp Aligned with ROIC Model Portfolio (-4.0%) underperformed the S&P 500 (+1.9%) from May 14, 2021 through June 14, 2021. The best performing stock in the portfolio was up 10%. Overall, one out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P 500 from May 14, 2021 through June 14, 2021.

This Model Portfolio only includes stocks that earn an Attractive or Very Attractive rating and align executive compensation with improving ROIC. I think this combination provides a uniquely well-screened list of long ideas because return on invested capital (ROIC) is the primary driver of shareholder value creation.

New Stock Feature for June: Target Corp (TGT)

Target Corp (TGT) is the featured stock in June’s Exec Comp Aligned with ROIC Model Portfolio.

I originally made Target a Long Idea in April 2015 before closing it out in May 2018. I again made Target a Long Idea in June 2019 and recently reiterated the position in March 2021. Since June 2019, the stock is up 171%% vs. +50% for the S&P 500. Despite the outperformance, I believe the stock still provides attractive risk/reward.

Target has grown revenue by 3% compounded annually and net operating profit after tax (NOPAT) by 6% compounded annually over the past ten years, per Figure 1. NOPAT margin increased from 5% in 2011 to 7% over the trailing-twelve-months (TTM).

Figure 1: Target’s NOPAT Growth: 2011 – TTM

Performance-Based Pay Properly Incentivizes Executives

Target’s executive compensation plan aligns executives’ interests with shareholder’s interests by tying the awarding of performance-based stock options to ROIC.

Target’s inclusion of ROIC as an executive compensation performance goal has helped drive shareholder value creation and economic earnings, per Figure 2. Target’s ROIC improved from 10% in 2016 to 20% TTM while its economic earnings grew from $2 billion to $5.6 billion over the same time.

Figure 2: Target’s Economic Earnings: 2016 – TTM

TGT Is Undervalued

At its current price of $237/share, TGT has a price-to-economic book value (PEBV) ratio of 0.7. This ratio means that the market expects Target’s NOPAT to permanently decline by 30%. This expectation seems overly pessimistic for a firm that has grown NOPAT by 6% compounded annually over the past decade.

Even if Target’s NOPAT margin falls to 4% (lowest since 1999 vs. 7% TTM) and the firm grows NOPAT by just 2% compounded annually over the next 10 years, the stock is worth $292/share today – a 23% upside. See the math behind this reverse DCF scenario. For reference, Target has grown NOPAT by 6% compounded annually over the past two decades. Should the firm grow NOPAT more in line with historical growth rates, the stock has even more upside.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in Target’s 10-K and 10-Qs:

Income Statement: I made $1.4 billion in adjustments, with a net effect of removing $897 million in non-operating expenses (1% of revenue).You can see all the adjustments made to Target’s income statement here.

Balance Sheet: I made $12.6 billion in adjustments to calculate invested capital with a net increase of $1.9 billion. One of the largest adjustments was $4.1 billion (13% of reported net assets) in asset write downs. You can see all the adjustments made to Target’s balance sheet here.

Valuation: I made $22 billion in adjustments with a net effect of decreasing shareholder value by $16.2 billion. Apart from total debt, the most notable adjustment to shareholder value was $2.9 billion in excess cash. This adjustment represents 3% of Target’s market cap. See all adjustments to Target’s valuation here.

Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.

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