MBA FPX 5014 Assessment 3 Financial Engineering to Enhance Shareholder Value

MBA FPX 5014 Assessment 3 Financial Engineering to Enhance Shareholder Value

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Capella University

MBA-FPX5014 Applied Managerial Finance

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Date

Financial Engineering to Enhance Shareholder Value – Target Corporation

Overview

Target Corporation, headquartered in Minneapolis, Minnesota, has been in operation since 1962. The company operates retail stores in all 50 states and claims that 75% of the U.S. population lives within 10 miles of a Target store. As a general merchandise retailer, its main competitors include Amazon, Costco, Lowe’s, Home Depot, and Dollar General Corporation, with Walmart as its principal competitor. Target is well recognized, with branding that includes its bullseye logo, a bulldog mascot, and a signature red store color that customers identify with even without seeing the Target name (Leinbach-Reyhle, 2014). Known for its “discount-chic” positioning, Target distinguishes itself through excellent service and bright store layouts. The company also boasts a legacy of community support, donating 5% of its profits to strengthen the communities it serves and achieving a perfect score on The Human Rights Campaign’s 2018 Corporate Equality Index (Target, 2021).

Target went public in October 1967 with an initial share price of $34. By the end of 2019, the stock was trading at $130, and in 2021, it reached as high as $188 per share. Notably, Target has paid a dividend every year since 1967 and has consistently raised its dividend for 47 consecutive years (Ballard, 2019). Target has not only managed its operations efficiently but also remained dedicated to enhancing shareholder value. This report will examine strategies used by companies to increase stock prices and evaluate Target’s financial statements to recommend strategies that may enhance its stock price and shareholder value.

Strategies to Increase Stock Prices

Shareholders invest in companies expecting returns through increased share value and dividends. While no specific formula guarantees higher stock prices, management can employ various strategies to enhance profitability and shareholder value. According to experts, there are three key strategies for driving profitability: revenue growth, improving operating margins, and increasing capital efficiency (Shareholder Value, 2020).

Revenue Growth: Companies can grow revenues by increasing sales volumes through expanded marketing, new products, or additional revenue streams. Another approach involves raising sales prices, either as a one-time measure or incrementally over several quarters. A balanced strategy of increasing both sales volume and prices can significantly boost revenue growth.

Improving Operating Margins: Companies can improve their operating margins by controlling costs, such as reducing Cost of Goods Sold (COGS) and Selling, General, and Administrative (SG&A) expenses. Methods to achieve this include negotiating better discounts with suppliers and improving return management systems, along with efficient handling of marketing, payroll, and overhead expenses.

Capital Efficiency: This strategy measures how effectively a company uses its capital, expressed as Return on Capital Employed (ROCE), the ratio of Earnings Before Interest and Tax (EBIT) over Capital Employed. A higher ratio indicates more efficient capital use, enhancing shareholder value (Shareholder Value, 2020).

Additional strategies companies may employ to enhance shareholder value include capital expenditures, stock buybacks, dividend policies, debt management, mergers and acquisitions, and geographic or demographic expansion. Target Corporation uses a combination of these strategies to maintain its competitive edge.

Financial Ratio Analysis

A review of Target Corporation’s financial statements and ratios for fiscal years ending February 2018, 2019, and 2020 was conducted to determine which strategies could improve shareholder value. Key ratios compared Target’s performance against its primary competitor, Walmart, and the industry standard.

Current Ratio: The current ratio measures a company’s liquidity and ability to meet short-term obligations. As shown in Table I, Target’s current ratio for the review period is slightly higher than Walmart’s but generally below the industry average of 1, which is acceptable for the retail industry. Despite the lower ratio, Target’s balance sheet indicates sufficient cash reserves to meet obligations and fund operations.

Inventory Turnover: Inventory turnover ratios reflect how efficiently a company manages inventory. Target’s ratios are lower than Walmart’s and the industry average, indicating room for improvement. Enhancing inventory turnover without heavy discounting can boost sales and cash flow, optimizing overall performance.

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Appendix A

The company’s cash management is efficient, with Target keeping significant cash reserves that allow it to invest in opportunities such as expanding its product and service lines and store locations. Accounts receivable, though moderate compared to other current assets, are reported at $468 million in 2019 and $464 million in 2020 (Target Corp., 2021). Target could further optimize its cash management by extending its payment terms and implementing aggressive collection procedures.

Debt to Equity Ratio
The debt-to-equity ratio measures financial leverage, indicating the extent to which a company uses debt to finance its operations. Table III provides a comparative view of Target’s debt-to-equity ratio relative to its main competitor and the industry average.

Table III: Comparative View – Debt to Equity Ratio

Note. Target Corp. (NYSE:TGT) (2021).

The industry average debt-to-equity ratio decreased from 1.27 to 1.0 and was consistently higher than both Target and Walmart. Target’s ratio is consistently around 1.0, which suggests a moderately favorable financial position, enabling the company to comfortably meet its long-term debt obligations. A lower debt-to-equity ratio indicates reliance on equity rather than debt, which may not be the most efficient strategy. Target may consider paying down some of its debt in the long term while maintaining current levels for flexibility in short-term borrowings.

Return on Equity

The return-on-equity (ROE) ratio measures how well a company uses its equity to generate profits. It is calculated as Net Income after tax divided by Shareholders’ Equity. Table IV provides a comparative view of Target’s ROE.

Table IV: Comparative View – Return on Equity Ratios

Note. Target Corp. (NYSE:TGT) (2021).

Target’s ROE ranges from 22% to 27% over the review period, which is particularly strong as the desired ROE for companies is between 15% and 20%. A high ROE is often attributed to high financial leverage, but this is not applicable to Target given its debt-to-equity ratio and debt levels discussed earlier.

Earnings per Share

Earnings per Share (EPS) is a key indicator of profitability, calculated as Net Earnings divided by Outstanding Shares of Common Stock. It is also a component of the P/E ratio, which helps investors and lenders assess the value of a stock. Table V presents a comparative view of Target’s EPS.

Table V: Comparative View – Earnings per Share (EPS)

Note. Target Corp. (NYSE:TGT) (2021).

Generally, higher EPS is viewed favorably. Target’s EPS has consistently increased each year and is higher than Walmart’s, suggesting strong performance and good earning potential.

Price to Earnings Ratio (P/E)

The P/E ratio is a market valuation metric that shows the economic status of a company, primarily used to determine if a stock is overvalued or undervalued. A higher P/E ratio suggests investor expectations of higher earnings. Table VI provides a comparative view of Target’s P/E ratio.

Table VI: Comparative View – P/E Ratio

Note. Target Corp. (NYSE:TGT) (2021).

Target’s P/E ratio is lower than Walmart’s but has been trending upward, indicating increasing stock value that aligns with industry levels.

Price to Book Value Ratio (P/BV)

he P/BV ratio compares a company’s market capitalization to its book value. Typically, market value is higher than book value, and the P/BV ratio is used alongside other ratios to gauge potential growth. Table VII shows the P/BV ratios for Target and Walmart.

Table VII: Comparative View – P/BV Ratio

Note. Target Corp. (NYSE:TGT) (2021).

Though Target’s P/BV ratio is lower than Walmart’s, it has shown growth over the three-year period, alongside its ROE. The growing ROE and P/BV ratio are positive signs for investors and lenders.

Recommended Strategies for Target Corporation

Based on the assessment of strategies to enhance stock price and financial ratios, the following recommendations could help Target achieve optimal performance and increase shareholder value:

1. Continue Stable Dividend Policy: Target has a history of paying regular quarterly dividends, enhancing its reputation as a reliable dividend stock. Maintaining this policy could attract new investors and support stock value growth.

2. Stock Repurchases: Target has been repurchasing its shares, reducing the number of outstanding shares from 538 million in 2018 to 500 million by 2020. This strategy has contributed to increased EPS and share price, enhancing shareholder value.

3. Introduce Revenue Growth Initiatives: Target could enhance its service offerings, particularly by investing in new delivery channels like drive-up pickup and shopping via the Target App. These changes would require store renovations and technology investments, which could boost competitive advantage and profitability in the long term.

4. Utilize Debt for Expansion: Given the favorable cost of debt, Target should consider using it to finance store renovations and stock repurchases, aligning with its current financial strategy.

Impact on Capital Structure and WACC

These recommendations will influence Target’s capital structure and Weighted Average Cost of Capital (WACC), calculated as follows:

WACC = (E/V × Re) + (D/V × Rd × (1 − Tc))

Where:
E = Market value of equity
D = Market value of debt
V = E + D
Re = Cost of equity
Rd = Cost of debt
Tc = Corporate tax rate

Using the values from the balance sheet for the period ending February 1, 2020:

This results in a WACC of 6.67%. The recommendations, particularly stock repurchases and the use of debt, will impact the capital structure and reduce WACC, supporting cost-effective capital management and enhancing shareholder value.

References

About Target – Our purpose and history. (2021). Target. https://corporate.target.com/about/purpose-history

Ballard, J. (2019, November 15). If You Invested $500 in Target’s IPO, This Is How Much Money You’d Have Now. The Motley Fool. https://www.fool.com/investing/2019/11/15/if-you-invested-500-in-targets-ipo-this-is-how-muc.aspx

Chen, J. (2020, November 19). Dividend Policy. Investopedia. https://www.investopedia.com/terms/d/dividendpolicy.asp

Fernando, J. (2021, January 3). Capital Expenditure (CapEx). Investopedia. https://www.investopedia.com/terms/c/capitalexpenditure.asp

MBA FPX 5014 Assessment 3 Financial Engineering to Enhance Shareholder Value

Hargrave, M. (2021). Weighted Average Cost of Capital (WACC). Investopedia. https://www.investopedia.com/terms/w/wacc.asp

Target Corp. (NYSE:TGT). (2021, March 9). Stock Analysis on Net. https://www.stock-analysis-on.net/NYSE/Company/Target-Corp