Is There An Opportunity With Target Corporation’s (NYSE:TGT) 23.81% Undervaluation?

In this article I am going to calculate the intrinsic value of Target Corporation (NYSE:TGT) by taking the expected future cash flows and discounting them to their present value. I will be using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not January 2019 then I highly recommend you check out the latest calculation for Target by following the link below.

Check out our latest analysis for Target

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The method

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow forecast

2019 2020 2021 2022 2023
Levered FCF ($, Millions) $2.30k $2.65k $2.94k $2.89k $3.10k
Source Analyst x9 Analyst x10 Analyst x4 Analyst x2 Analyst x2
Present Value Discounted @ 8.55% $2.12k $2.25k $2.30k $2.08k $2.06k

Present Value of 5-year Cash Flow (PVCF)= US$11b

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.7%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.5%.

Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = US$3.1b × (1 + 2.7%) ÷ (8.5% – 2.7%) = US$55b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$55b ÷ ( 1 + 8.5%)5 = US$36b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$47b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of $90.36. Compared to the current share price of $68.84, the stock is about right, perhaps slightly undervalued at a 24% discount to what it is available for right now.

NYSE:TGT Intrinsic Value Export January 15th 19
NYSE:TGT Intrinsic Value Export January 15th 19

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Target as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.5%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For TGT, there are three important factors you should look at:

  1. Financial Health: Does TGT have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does TGT’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of TGT? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow for every stock on the NYSE every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.