The Multiline Retail Industry

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1. Overview of the Industry

The multiline retail industry consists of operators of department stores and stores that sell diversified general merchandise to consumers for personal, family, or household use. Key players in US multiline retail industry include department stores such as Macy’s, discount stores such as DollarTree, general merchandise stores such as Wal-Mart, and Internet retailers such as Amazon. Although there are a variety of retailing categories in the US market, we identify Wal-Mart, Dollar Tree and Dollar General as Target’s closest peers, since they all carry a broader assortment of merchandise than most department stores and sell their products predominantly from a fixed point-of-sale location with affordable prices.

In the short term, the industry would still be dominated by traditional brick-and-mortar stores, while e-commerce is capturing more market share through omni-channels and compelling consumer experiences. Increasing competition between physical and online retailers has made both sides to adjust their strategic positioning to capture growth opportunities in the future. More traditional retailers start to adopt digital sales to increase their revenues, and pure-play e-retailers have also launched physical stores. Moreover, retailers tend to expand private label offerings and enhance loyalty programs in response to the recent increase in consumer price sensitivity. With effective use of private labeling, retailers are able to achieve extra profit margins and build differentiable brand image that adds to customer loyalty.

In the long run, multi-channel selling is expected to become a dominant trend in the multiline retail industry. By offering a combination of physical and online shopping experience, a retailer would not only maximize its customer reach but also boost its total sales. Also, with increasing disposable personal income, customers would become more willing to spend money on consumer goods, which further supports the positive long-term growth of the multiline retail industry.

1. Company Overview

1. Description: Target Corp (Target), founded by George Dayton and headquartered in Minneapolis, is 2nd largest general merchandise store in US, with 1,822 large merchandise and food discount stores as of 2018. It sells a broad range of household goods, food and pet supplies, apparel and accessories, electronics, decor, and other items through physical and online channels. Its target customer segments include middle- and upper-income consumers.
2. Strategic Positioning: Firstly, Targets differentiates itself through digital sales. Since 2017, it has invested greatly in digital enhancements. Besides, it is optimizing brick-and-mortar stores by redesigning stores, and opening small-format urban stores. In FY18, Target plans to open 30 small-format stores and remodel more than 300 existing locations. Thirdly, Target is focusing in inventory-management analytics to save labor cost, increase the productive capacity of inventories in story rooms and store shelves to achieve a more efficient distribution. Overall, Target is integrating its online E-Commerce and physical stores, aiming to provide its customers with a seamless experience whether shopping in stores, online, or through mobile apps.

1. Future Perspective

1. Growing E-Commerce Industry: We see that Target is stressing integration of E-Commerce and brick-and-mortar operations, further strengthening its position as an omni-channel retailer. On the other hand, E-Commerce specialists as Amazon offers appealing price and convenient delivery strategies, which puts Target into a difficult position where it is hard to win over online market share. In the short run, we believe that Target would benefit from its shift to E-Commerce, boosting its sales to larger extents; whereas in the long run, Target might take risks in facing more competition than expected. We assume that sales will increase steadily in the next 5-6 years, reaching peak in 2024, then starting to fall due to increasing competition.
2. Price Competition: With more price-sensitive customers, retailers compete heavily in price competition. Target may be dragged into a position where discounts somehow define growth. To survive, Target may strive to retain customer base and stay competitive by offering lower price.
3. Growth in private label acceptance: Target continues developing its private brand, trying to reignite the former success on new brands in apparel, home and workout apparel. To further improve customer relationships, Target will have to continue outmaneuvering Wal-Mart and improving its own financial metrics.

1. Revenue and FCF forecasts for the next 10 Years

Based on the analyst reports issued by Argus and Credit Suisse, we predicted that Target’s total sales will increase rapidly in the next several years due to its innovative omni-channel selling strategy. However, Target is likely to experience fierce competition with its

Therefore, we assume that Target will be facing an overall positive growth trend. However higher growth in sales is expected in the first 6 years, with slower but positive growth in the long run. Based on this assumption, we calculated Free Cash Flow in the next 4 years correspondent to this trend (Exhibit_). The results helped us in calculating terminal value and intrinsic value of Target in the following DCF analysis.

1. DCF and Sensitivity Analysis

To calculate WACC for Target, we used the 30-year Treasury bond yield of 3.33% as the risk-free rate and the market risk premium of 5.50% as indicated in KPMG’s 2018 Research Summary1. We applied the CAPM model and estimated Target’s cost of equity to be 7.68%. Since Target has an A bond rating. We also used the yield on a 20-year A-rated bond of 4.1% as our estimation of Target’s cost of debt. Assuming a 34% tax rate, we determined Target’s Weighted Average Cost of Capital to be 6.68%.

Under Gordon Growth Model, we assumed a terminal growth rate of 3.00%, which is identical to Target’s long-term growth rate given in Argus’s report2. The terminal value at the end of 2028 is estimated to be $67,278.91 million, calculated by dividing projected FCF in 2029 by the difference between WACC and terminal growth rate. By discounting our projected FCF and terminal value to the present period using WACC of 6.68%, we got Target’s intrinsic enterprise value of $49,434.68 million and equity value of $38,282.68 million respectively. After dividing the intrinsic equity value by the number of shares outstanding, we finally determined the value per share to be $71.42. We then calculated the terminal value by assuming the EV/EBITDA Multiple to be 8.9X in FY 2028. This is the median EV/EBITDA of the six major general merchandise retailers in the U.S. As indicated in the case. We obtained the terminal value of $86,629.42 million by multiplying Target’s 2029 EBITDA by 8.9 and combined it with projected FCF to get Target’s intrinsic enterprise value of $59,569.44 million. Our estimation of Target’s value per share using the EV/EBITDA Multiple Model was $90.33.

We also conducted sensitivity analysis for the two models separately to see how our assumptions would affect the result of Target’s value per share. As can been seen from Exhibit_, we performed a sensitivity analysis of DCF Model by setting WACC ranging from 4.68% to 8.68% and growth rate from 2% to 4%. The most pessimistic value was 33.34 and the most optimistic value was 438.6. Under the Multiple Model, we also set the WACC from 4.68% to 8.68% with the multiples ranging from 6.9 to 10.9. The result reveals the highest value of 215.05 and lowest of 57.75.