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Stock Strategist

Market Is Giving Target Too Much Credit for a Sensible Strategy

We believe better investment opportunities exist in the retail defensive space.

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 Target's (TGT) recently updated strategy is an appropriate one, as it leverages the company's well-known brand, convenient locations, and competitive scale. That said, we think the current share price fully reflects comp acceleration and U.S. margin expansion and essentially values no-moat Target like a wide-moat retailer. We think investors should note the lower likelihood of long-term outperformance for Target and consider Wal-Mart (WMT) as a more attractive option.

Target's decision to exit Canada should allow management to focus investments on the U.S. business, in which the company intends to concentrate on five strategic pillars: on-demand shopping, signature categories, localization, urban formats, and cost cuts. If successful, Target's omnichannel and REDcard strategy could drive per customer spending higher, and the firm could still justify operating with a large store base amid intense competition from the online channel. However, switching costs are virtually nonexistent in the retail channel, and we don't see conclusive evidence that Target commands a throughput-driven cost advantage over other big-box rivals or that it is able to charge sustainable price premiums in its categories. Even after factoring in differences in growth rates between Target and wide-moat Wal-Mart, Target still trades at a higher valuation than Wal-Mart, which we see as a more attractive option given our view that wide-moat firms deserve higher valuations than no-moat retailers, all else equal.

Ken Perkins does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.