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Target Corporation's (NYSE:TGT) Intrinsic Value Is Potentially 43% Above Its Share Price

Simply Wall St ·  Mar 27 19:48

Key Insights

  • The projected fair value for Target is US$246 based on 2 Stage Free Cash Flow to Equity
  • Target is estimated to be 30% undervalued based on current share price of US$173
  • Our fair value estimate is 35% higher than Target's analyst price target of US$183

Today we will run through one way of estimating the intrinsic value of Target Corporation (NYSE:TGT) by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Step By Step Through The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$2.48b US$3.74b US$3.83b US$4.20b US$4.37b US$4.66b US$4.87b US$5.07b US$5.24b US$5.40b
Growth Rate Estimate Source Analyst x5 Analyst x8 Analyst x7 Analyst x4 Analyst x2 Analyst x1 Est @ 4.68% Est @ 3.96% Est @ 3.46% Est @ 3.11%
Present Value ($, Millions) Discounted @ 6.0% US$2.3k US$3.3k US$3.2k US$3.3k US$3.3k US$3.3k US$3.2k US$3.2k US$3.1k US$3.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$31b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.3%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$5.4b× (1 + 2.3%) ÷ (6.0%– 2.3%) = US$148b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$148b÷ ( 1 + 6.0%)10= US$82b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$114b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$173, the company appears a touch undervalued at a 30% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
NYSE:TGT Discounted Cash Flow March 27th 2024

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that 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 weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 6.0%, which is based on a levered beta of 0.812. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Target

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
  • Dividends are covered by earnings and cash flows.
  • Dividend information for TGT.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Consumer Retailing market.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Annual earnings are forecast to grow slower than the American market.
  • What else are analysts forecasting for TGT?

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Target, we've put together three fundamental factors you should assess:

  1. Risks: For instance, we've identified 2 warning signs for Target that you should be aware of.
  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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

The above content is for informational or educational purposes only and does not constitute any investment advice related to Futu. Although we strive to ensure the truthfulness, accuracy, and originality of all such content, we cannot guarantee it.
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