Target stock: Expect more, pay less

NEW YORK (CNNMoney.com) -- Chalk it up to the company's eye-popping ads or its "cheap chic" merchandise, but Target has been one of the biggest retail success stories of the past decade.

Yet the No. 2 discount chain still has plenty to prove.

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The company's stock is up about 5 percent this year - lagging the broader market as well as some key rivals. And Target has been forced to play catch up lately with the reigning retail champ Wal-Mart (up $0.13 to $46.52, Charts) on new initiatives such as discount prescription drugs and organic food.

And just like its company logo, Target appears to have a giant red bulls eye on its back, facing threats from reinvigorated department store chains such as J.C. Penney (up $1.29 to $80.84, Charts), Kohl's (down $0.15 to $72.79, Charts) and even Sears (up $1.31 to $176.11, Charts). Shares of these three discounters have outperformed Target by a wide margin this year.

Next week, Minneapolis-based Target (up $0.46 to $57.03, Charts) hopes to get back in Wall Street's good graces when it reports third-quarter earnings. Investors will be paying particularly close attention to what Target says about the crucial fourth quarter - when store chains rake in as much as half their annual sales and profits over the holidays.

Can Target put up impressive holiday sales in what many experts say will be a lackluster shopping season?

When Target reports next week, look for earnings of 55 cents a share, and $13.5 billion in revenue, according to analysts surveyed by Thomson First Call.

The results will highlight its back-to-school performance and will include disappointing sales for August and October. In those two months, Target's monthly sales at stores open at least a year met company estimates by climbing over 3 percent, but fell short of Wall Street expectations.

Prudential Equity Group analyst Mark Rowen doesn't think Target is to blame for the soft sales. He said slower consumer spending in general was the problem.

But now Target has the holiday season ahead. Most analysts expect a good quarter even though overall holiday sales are expected to rise just 5 percent, down from a 6.1 percent increase last year, according to the National Retail Federation.

Analysts have Target pegged to rake in $19.4 billion in sales during its fourth quarter, which ends in January. That's up 15 percent from a year ago. Wal-Mart, by way of comparison, is expected to report a 12 percent increase in sales during the holidays.

Ed Weller, an analyst with ThinkEquity Partners, thinks Target will grow faster than some of its peers because the company sticks to what works, such as "cheap chic" merchandise from high-profile designers like Isaac Mizrahi and Todd Oldham. Clever marketing campaigns also help.

"Their strategy works for them because it gives them a unique position in the marketplace and helps them build the franchise," said Weller.

But even being No. 2 in the discount food chain, Target still has plenty of room to grow, which may very well be one of its biggest advantages, analysts said..

Right now, the company operates 1,494 stores in 47 states, and it has yet to tap into Canadian or Mexican markets like Wal-Mart, which said last month it was slowing its store growth in the United States.

Target expects to open 74 domestic store over its fiscal year ending in January 2008. And Target has found success with SuperTarget stores, which feature groceries in addition to other discount merchandise.

Even though SuperTargets comprise only about 11 percent of its stores, retail analysts expect those stores to play an important part in the company's future.

"They have been able to keep that model working well," said Marshal Cohen, chief analyst at the market research firm NPD Group. "It's not the size of the store - it's the fact that they have a better mix of products for a wider variety of consumers."

But Target still has to contend with Wal-Mart and other rivals.

Even though Wal-Mart has so far failed to duplicate Target's success in attracting upscale customers, Wal-Mart sets the bar when it comes to pricing. So if Wal-Mart manages to find an antidote to its recent sluggish performance and win back more bargain-conscious consumers, that could be bad news for Target

"If Wal-Mart gains (market) share at some point, it could come from Target," warns Prudential's Rowen.

Department stores Penney and Kohl's, which have found new life this year, could also be a threat. Kohl's in particular has become a mall alternative to Target for busy families with kids, said ThinkEquity's Weller.

But despite some competitive risks, most analysts are pretty bullish on Target stock, saying the company's on solid footing and should continue to gain share in the discount retail market.

And the stock does look like a bargain. Although shares of Target trade at a premium to Wal-Mart, it's still cheaper than some of its department store rivals.

Looking at next year, the stock trades at about 16 times analysts' earnings forecasts. Wal-Mart trades at about 14.5 times estimates but Sears trades at about 17 times and Kohl's has a price-to-earnings ratio just above 19.

Prudential's Rowen said it's reasonable to expect that Target could trade at a higher valuation.

Target's earnings, after all, are expected to grow about 15 percent a year the next few years, on average, according to analysts' consensus estimates. Wal-Mart's expected growth rate is 13 percent while Sears' is just 11 percent.

Wall Street seems to agree that the stock is relatively cheap as all but one analyst rate the stock a 'buy'. According to Thomson First Call, the consensus 12-month price target for Target is $63.73, some 12 percent higher than its current price of about $57.

So long as the economy doesn't tank and Target is able to keep its rivals in the rearview mirror, there's no better way to sum its stock than with its company's slogan: "Expect More, Pay Less".

None of the analysts quoted in this story own shares of Target. None of the firms have an investment banking relationship with the company.

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