Here's a Blue Chip Dividend Stock You Absolutely Need in Your Retirement Account

This top dividend stock yields more than 3% and has paid higher dividends for more than 50 years. Should investors jump in?
By Brian Bollinger ,

Target (TGT) - Get Report has paid a consistent, growing dividend since its initial public offering in October 1967 and has more recently increased its dividend at a 19.6% compound annual growth rate over the past 10 years.

Its impressive track record and stable business model qualifies Target for consideration in our Conservative Retirees dividend portfolio.

The company looks attractive with a more than 3% yield, the potential for further dividend increases and a price-earnings ratio of 14 times. However, with the competitive threat from e-commerce and specifically Amazon, should investors be concerned?

Target was incorporated in 1902, but its first discount store opened in 1962. The company has nearly 1,800 locations across the U.S.

The company's stores focus on convenient one-stop shopping and competitive discount prices, offering a broad range of products such as apparel, appliances, baby care, beauty, electronics, food, furniture, movies, personal care and much more.

Target is the second-largest general merchandise retailer in America, second to only Walmart.

Compared with Walmart, Target is much smaller ($73.8 billion in sales last year versus $482 billion at Walmart), has a smaller grocery business (21% of sales versus 56% at Walmart) and targets a relatively wealthier demographic. Target's typical customer is 40 and has a median household income of $64,000.

About one-third of Target's sales is related to its owned and exclusive brands. The rest of its products are mostly national brand merchandise.

With all the hype surrounding Amazon and e-commerce growth, it is easy to forget that a brick-and-mortar retailer can still earn decent returns and have barriers to entry.

Target is a relatively attractive business, with economies of scale in merchandising and distribution. Smaller competitors simply can't get the same terms in negotiating with suppliers and have similar scale and technology in managing their inventory.

Although these characteristics illustrate that Target isn't going anywhere anytime soon, revenue growth has been tepid, with a trailing five-year CAGR of 1.8%. This is extremely important for dividend investors looking to see the income stream grow each year because eventually, dividend growth will come from increasing cash flow and earnings, even if the payout ratio is low.

Over the past few years, the company has managed through a number of issues, including a notorious data breach and disastrous expansion into Canada. These factors, along with very low new store expansion and the market shifting to e-commerce, are responsible for the poor historical top line growth.

How normalized revenue growth should trend can be estimated by analyzing two critical factors for a retailer: same-store sales and net new store openings.

Same-store sales is a function of price and traffic.

Because it is unlikely that Target will experience a material mix shift in merchandise, price will be driven by inflation. This can be counted on for about 1% to 2% growth.

Traffic is more difficult to forecast because at any time it could be driven by consumer sentiment toward Target versus other brick-and-mortar retailers and e-commerce.

U.S. population growth is expected to grow at a 0.5% CAGR through 2050, which provides confidence that traffic should grow in a normal environment. But the real issue is if large brick-and-mortar retailers remain relevant decades from now for consumers' day-to-day purchases.

Target does have a successful digital website that contributes to about 3.4% of company sales, so hopefully it will be able to offset the potential declines in traffic to it stores with volume on its website. Overall, Target's same-store sales growth looks like it will average 1% to 2% a year.

The other major driver of sales growth is net new store openings. This is the difference between new stores opened and the closings of existing stores.

From the early 2000s through 2010, Target averaged high-single-digit growth. However, this growth has slowed considerably starting in fiscal 2011 and was actually negative in fiscal 2015 and flat for the fiscal year ended Jan. 30.

Target has spent less and less on new store openings each year.

Its new store capital expenditures have gone from $574 million in fiscal 2010 to just $115 million in fiscal 2015. This is reflected in total store count only increasing from 1,750 to 1,792 during that time frame.

Needless to say, don't count on net new store growth contributing meaningfully to the top line.

Adding up all these growth drivers over the long term indicates that Target will likely increase its top line at a sub-gross domestic product rate of 1% to 2%. However, the business should perform relatively better than the overall economy during recessionary periods because it is a discount retailer.

Meanwhile, in terms of dividends, Target has paid 196 consecutive quarterly dividends on its common stock since it went public, which puts it on the list of dividend kings and also makes it a member of the Dividend Aristocrats Index

More recently, Target said that it will raise its dividend quarter over quarter by 7.1%.

In analyzing 25-plus years of dividend data and 10-plus years of fundamental data to understand the safety and growth prospects of a dividend, our Safety Score answers the question, "Is the dividend payment safe?"

We look at factors such as current and historical earnings per share and free-cash-flow payout ratios, debt levels, free-cash-flow generation, industry cyclicality and return on investment capital trends.

Our Growth Score answers the question, "How fast is the dividend likely to grow?"

It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics such as sales and earnings growth and payout ratios.

Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

Target's dividend is very safe, as demonstrated by a Safety Score of 95, and it shows good growth potential with a Growth Score of 82.

The company has raised its dividend at a 19.6% CAGR over the past 10 years and a 13.7% CAGR over the past three years. The dividend should be supported by Target's stable business model and relatively low payout ratio of 46.5%.

The relatively low payout ratio will allow Target to increase the dividend in excess of its earnings-per-share growth for some time, but eventually the company will need to increase earnings and cash flow to sustain the historical dividend growth rates.

Target is a blue-chip dividend stock that appears to be a good investment, especially for investors living off dividends in retirement and seeking a safe high-yield stock. The company has paid an uninterrupted dividend since the 1960s, has a stable business model through economic cycles, generates consistent free cash flow, has a relatively low payout ratio, and trades at a reasonable P/E ratio in the low teens.

However, investors who are looking to invest in a true dividend growth company should pass on Target because of the limited growth opportunities for the company.

This article is commentary by an independent contributor. At the time of publication, the author held no position in Target.

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