Joe Raedle

You may remember an article I wrote on Target Corp. (NYSE: TGT) a few months ago titled, Target: a dividend king on sale. In this article, I explained

If you are looking for uncompromising safety, quality, growth potential and value, Target is one of the best aristocratic bear market deals you can buy.

If you’re looking to sleep well at night, knowing your dividends are safe and growing in all economic conditions, Target is a great choice.

Are you looking to potentially earn Buffett-like 19%-20% annual returns over the next three to five years? Then Target is a dividend king to consider.

Target bought at $155

Yahoo finance

I’ve always wanted to own shares of TGT, as I dreamed of owning shares of McDonald’s (MCD), another awesome “wide bass” stock that also owns a fair amount of real estate. In a recent Seeking Alpha article, Ryan Thomson explains:

The majority of franchised restaurants are under a “conventional” franchise, in which McDonald’s owns or leases the land and building from which the franchise operates.

Rent payments received from franchisees are in fact the single largest component of revenue McDonald’s receives from its franchises, accounting for more than 60% of franchise revenue in 2021 – more than a third of total company revenue. McDonald’s.

The advantage of this model is that it gives McDonald’s some of the characteristics of a real estate business, providing visible and stable revenue streams over long periods of time – typically 20 years under a typical franchise agreement. Minimum rents for 2022-26 are about $3 billion a year, or 13% of revenue (based on FY21 levels).

You may remember a Forbes article I published about McDonald’s about seven years ago, right after activist investor Glenview Capital Management harassed McDonald’s to turn its real estate into REITs.

Since the McDonald’s real estate empire has such a small base, there’s likely to be quite a spread (difference between the franchisee’s rent and the rent paid to the REIT), but most of the rental proceeds must be paid to the REIT in order to be competitive in its dividend payments…

I continued to explain,

By divesting the franchise’s leased assets, McDonald’s would not only be moving away from an incredible cash cow, but also forking the control factor on which the global hamburger empire was built.

Even if a proposed McDonald’s REIT were formed, franchise leases would be significantly above market and it would be difficult for McDonald’s to conduct arm’s length transactions with franchisees. Many relationships go back decades and the complications would be extraordinary.

These days, it would be difficult for McDonald’s, or any C-Corp, to turn their real estate into REITs, simply because Congress closed that loophole in 2018 that forced the hand of companies that wanted to turn their real estate into a taxable REIT – the distribution of real estate or operating assets is no longer exempt from tax.

So now, C-Corps who wish to consider a REIT structure no longer enjoy tax benefits. However, this does not apply to REIT-to-REIT spins that have created vehicles like Orion Office REIT (ONL) and Urban Edge Properties (UE).

Now back to the target…

I’ll admit it, one of the main reasons I bought TGT in the first place is because of its vast real estate empire. Take a look at the file below:

Target stores and distribution centers

TGT: 10K

As you can see, TGT owns 1,528 stores (only 242 leases) in fee simple and another 156 stores on leased land. The average TGT store is 126,000 square feet.

Additionally, TGT has 34 of its 48 distribution centers, and the average distribution center is 1.2 million square feet.

  • Owned real estate: 193 million square feet
  • Owned real estate (on leased land): 19.7 million square feet
  • Owned distribution centers: 40.8 million square feet
  • Combined: 253.5 million square feet

That, my friends, is a lot of real estate, compared to these REITs:

  • Prologis Inc. (PLD) owns 1 billion square feet
  • Simon Property (SPG) owns 175 million square feet in the United States
  • Ventas (VTR) owns 18 million square feet

In other words, TGT’s property portfolio is 25% the size of PLD and more than SPG and VTR combined.

I could see now why the C-Corp REIT spin loophole was closed, and if you think Medical Properties (MPW) has a lot of focus with Steward, a Target REIT would have been fun to watch (and write about).

Target business model

Clearly Mr. Market is unimpressed with TGT’s operations, the company has had supply chain issues which have increased inventory costs, leading to cost reductions in many categories.

The company cut its guidance (twice) and the latest earnings were painful to watch as inventory on the balance sheet was about $6 billion higher than it said three years ago, and approximately $3 billion (about half of this total growth) was the result of higher unit costs in our assortment.

In the most recent quarter, TGT generated earnings of $0.39 per share, down 89% from earnings of $3.65 per share last year.

Remember that retailers such as Walmart (WMT) and TGT use a fiscal year which ends on January 31 rather than December 31, because December is their busiest month due to the holiday season, and they prefer to wait until the end of the holiday season to close their year-end books.

Thus, analysts estimate that TGT will generate around $8.13 EPS in 2022, around $1.75 per share more than in 2019.

Meanwhile, TGT continues to launch tantalizing dividend increases, the latest being $417 million in dividends paid to shareholders in the second quarter, up from $336 million a year ago, thanks to a 32% increase in the dividend per share.

You know what I think, “the safest dividend is the one that has just been raised”.

EPS target 2021 and 2022

QUICK charts

Now, what’s even more telling is that the analyst estimates EPS for 2023 at $11.94 per share, and if that happens, TGT will have its second most profitable year in its entire history.

What’s not to like about that?

Now some icing on the cake

When you check under the hood you can see some really impressive assets, and of course I’m referring to brick and mortar.

Remember that TGT is A-rated and although it doesn’t need capital, it could easily transact 10%-25% of its owned stores through a direct sale-leaseback with a company like Real estate income (O).

Just for fun, suppose TGT took 10% of its own stores, or 150 stores (averaging 126,000 square feet) and sold them to Realty Income. My napkin back:

  • 1 store (126,000 square feet) leased at $5.00 NNN and applying a cap rate of 5.5% = $11.5 million
  • 150 stores x $11.5 million = $1.725 billion

Incidentally, Realty Income is fully capable of transacting on a $1.725 billion sale-leaseback, given its current size ($58 billion enterprise value) and the recent agreement with Wynn Resort (Encore Resort and Casino) for $1.7 billion at a capitalization rate of 5.9%.

Now, there are tax leaks to consider, but a sale-leaseback with TGT would put about $1.2 billion back into the work of the major retailer, and given today’s stock price drop, buying back shares would be one of the best ways to reinvest in the business.

So what if TGT bought back $1 billion in stock?

Target annual ROR

QUICK charts

What do 25% annual returns look like?

The shares are now trading at 15.8x with a dividend yield of 2.6%.

While my checkbook isn’t big enough to become an activist (currently), I think the leaseback conversation is worthy considering the discount reflected and compared to WMT’s multiple today (trading at 22x).

My “suggestivist” approach is often noted, particularly when my calls regarding Iron Mountain (IRM) – regarding sale and leaseback – Franchise Group (FRG) – regarding Badcock – and Gaming and Leisure (GLPI) – regarding Bally’s – resulted in profits from real estate.

Look people, Target is sitting on a gold mine of real estate and Mr. Market has no idea what the discount chain could do with it.

Show me another A-rated Dividend King that has this leverage on the balance sheet?

Remember, when you buy shares of Target, you also get 1,528…

Target store

And 34 of them:

Target stores

Who cares about Target REIT, I’ll just buy Target the C-Corp., recognizing that I’m getting cheap retail stock and billions of dollars in high-quality real estate.

Ray Kroc was heavily in debt and mortgaged his house as the number of McDonald’s kept growing day by day. That’s when a clever lawyer told him,

Mr. Kroc, you don’t quite understand the real business in which you work. You’re not in the business of selling burgers.

So what is it?” he asked the lawyer. The lawyer said,

You’re in the real estate business Mr. Kroc.

The rest is history!