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Target Corporation (TGT), Costco Wholesale Corporation (COST): Consider Buying This Stock on Weakness

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If you follow my articles, then you know that I’m not bullish on most retailers. There isn’t much reason to be optimistic considering all the headwinds the consumer faces, including increased payroll taxes, high gas prices, underemployment, and rising mortgage rates. However, some retailers offer a little more safety because they focus more on what people need instead of what they want. Target Corporation (NYSE:TGT) fits into the latter category.

Recent performance
In the second quarter, sales increased 4% to $17.12 billion year over year. U.S. sales improved 2.4% to $16.84 billion. Target Corporation (NYSE:TGT) opened 68 new stores in Canada in the first half, as well as 10 new stores in the United States, which aided the top line. Looking at the bottom line, diluted earnings-per-share declined 10.4% to $0.95.

Target Corporation (NYSE:TGT)Target Corporation (NYSE:TGT) plans on opening a total of 124 stores in Canada in 2013, which should continue to boost top-line performance. However, there will be expenses associated with these openings which will impact margins. This fact, combined with increased competition and a tentative consumer, is likely to impact Target’s profitability. For instance, Target now expects FY 2013 earnings-per-share to come in at the lower end of the following range: $4.70-$4.90, citing household budgetary constraint.

Good news on the top line and bad news on the bottom line can lead to confusion. Therefore, we need to take a look at the most important metric — comps.

The most important number in retail
For Target Corporation (NYSE:TGT), comps include stores that have been open at least 13 months. Overall, comps increased 1.2%. At first glance, this looks positive. However, it does indicate declining sales growth at established stores because comps grew 3.1% in the year-ago quarter. The number of transactions at comparable stores also declined 1.4% compared to a 0.7% increase in the year-ago quarter. The good news is that average transaction amount and selling price per unit both performed better year over year, showing improvements of 2.7% and 1.6%, respectively. In the year-ago quarter, these numbers grew at 2.4% and 1.1% clips. Units per transaction improved 1% which was not as fast as the 1.3% rate seen in the year-ago quarter.

The takeaway is that not as many people are visiting Target Corporation (NYSE:TGT) stores. Those who do visit Target stores spend more money than they did a year ago. This likely has to do with Target’s ability to identify what consumers need (and want). Broad product diversification doesn’t hurt, either. High gas prices might also be a factor — consumers aren’t as likely to store hop as they were in the past. Consumers want to shop all in one place, which Target offers.

The picture still isn’t crystal clear. Target Corporation (NYSE:TGT) is good at generating cash flow, which it uses to pay off debt, invest in its existing business, and reward shareholders via dividends and buybacks. These are all positives. In the second quarter alone, Target spent $231 million in dividends and $927 million in buybacks. Currently, Target yields 2.70%.

Another positive is that Target Corporation (NYSE:TGT)’s REDcard penetration has increased to 18.7% from 12.8% in the year-ago quarter — a sign of improved customer loyalty.

With regards to growth potential, Target Corporation (NYSE:TGT) is making strategic moves by expanding in Canada (healthier consumer than in the U.S.) and opening CityTarget stores. This has enormous potential, since it’s likely to attract a lot of foot traffic.

Target vs. peers
Target Corporation (NYSE:TGT) has clearly established an effective strategy. The company’s marketing and brand are both strong, growth is likely, and cost management is good. However, that doesn’t guarantee it’s the best investment option in its peer group.

Costco Wholesale Corporation (NASDAQ:COST), has extremely loyal customers, thanks to a top-tier shopping experience as well as geographical and product diversification. Costco’s June and July comps improved 4% and 6%, respectively, year over year. Costco should continue to reward its shareholders. A 1.10% yield is an added bonus.

Wal-Mart Stores, Inc. (NYSE:WMT) is by far the largest of the three, sporting a market cap of $238.84 billion, versus a market cap of $40.18 billion for Target Corporation (NYSE:TGT) and a $48.80 billion market cap for Costco. Wal-Mart’s size, global exposure, product diversification, and brand diversification with Sam’s Club give it tremendous resiliency to any market weakness.

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