DGI Adventure 08-23-16 Sold Cash Secured Put + Investment Thesis – Target Corporation (TGT) – $69.00 strike – September 02 Expiration

This trade was actually executed on Wednesday 08/17/16. I didn’t get a chance to write about it until today.

Please visit the core philosophies article on my investment thesis process for a deeper explanation of the components of this article.

Dividend Cycle

TGT went ex-dividend on 8/15, two days before this trade. Target is a dividend champion, boasting 49 consecutive years of dividend increases. The company is in the habit of raising it’s dividend for the September distribution (Aug ex-div). They didn’t disappoint this year; the current payout was recently raised from $0.56 to $0.60, a 7.1% increase. The premium received for this trade is $0.14 less than the dividend payout, but it expires a week before the actual pay date, and is only in force for just a bit over 2 weeks.

Investment

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The QC (Quantitative Case)

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*Note: Target has sold some stuff the last couple years, so their “net cash used for investing activities” has actually been positive for the last two years. If we use the TTM cash for investing number (+$535M), the dividend cushion ratio metrics are all clear. Capex has been between $1.3B and $1.7B the last three years. I used -$1.0B for the “cash for investing” value. So everything is yellow, because I didn’t project positive “invested cash” for the next 5 years, but these metrics would actually be worse if I had just used TTM capex. 

Whatever. The dividend cushion is at least positive. I’d like to see the debt come down a bit. That’s obviously the issue here.

SPL (Strike Price Logic)

At $69/share the $2.40 annual dividend is a 3.5% yield. You might remember that on 8/17, TGT shares plunged after the company announced quarterly earnings.

$67 and $68 have been support levels over the last year.

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TGT One Year Chart – Courtesy Yahoo Finance

The premium for the $68 and $67 strikes wasn’t good enough though. $69 was acceptable, so $69 was the strike. Not loads of downside protection, but not bad. Quick turnaround too at 16 days. I’ll take it.

QWaF (Qualitative Warm and Fuzzy)

I’m pretty cheap, so I get a lot of my clothes at Target. It’s not like I shop at Target all the time, but they get more than their fair share of my business. My understanding is that they treat their employees (Team Members) pretty well compared to other big retailers (WMT for example).

If I have a choice between a Wal Mart and a Target, I’m probably going to pick the Target. And I already own WMT shares, so only seems natural that I go long TGT too right?

Much like that purchase last year of WMT, this was a bit of a contrarian reaction to the earnings headline.

49 years of dividend increases is a pretty impressive record, and it demonstrates a managerial commitment to returning value to shareholders.

TGT is a discount retailer, but it’s like, a little upscale? They should continue to benefit as the American consumer continues to recover from the great recession, but as a discounter they should also do okay if things get bad…right?

CPR (Cold and Prickly Risks)

When you’re that big, substantive growth is tough. 7% is asking a lot. Is the US market saturated? Management is still licking their wounds from their ill-advised foray into Canada…

Also Amazon (AMZN) is supposedly “eating everyone’s lunch” in the retail space.

If you’re an idiot, you might think that their gender neutral bathroom and children’s clothing policies might affect traffic because it will detract a certain breed of customer in middle America. 

Of course, as an equal opportunity purchaser of political power, they’ve also funded anti-gay politicians, convoluting the message, and adding nut job boycotts from the left as well.

I think the politics is really just noise.

My biggest concern is the debt. For better or worse, it seems like we’re starting a rising rate cycle, which should contract consumer spending to some degree. If they’re going to keep raising the dividend at a rate similar to their historical averages, they need to increase cash flow, which ultimately has to mean more sales, which won’t be easy. The debt position they’ve gotten themselves into is relatively reasonable, but does not leave much room for error.

This isn’t their first cycle, however. I think the extensive track record warrants the benefit of the doubt.

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