Bet on Target’s Recovery with LEAPS

Target Corporation (TGT) shares have retraced to their $50 level after an analyst downgraded the stock citing a weaker sales environment next quarter. Lazard Capital Markets downgraded the retailer to “hold” from “buy” noting rising deliquencies and sustained margin pressures during an uncertain credit environment. However, many experts believe the true value of Target lies in its assets rather than its operating results.

William Ackman’s Pershing Square Capital Management owns more than 10 percent of Target and has insisted that the stock is undervalued. The activist investor noted that the retailer’s owned real estate portfolio could be worth in excess of $50 billion while its credit card portfolio was also undervalued by those on the street. Ackman suggested that Target explore leaseback transactions to unlock the value of its real estate while divesting its credit card divesting to raise cash for buybacks.

Target has already sold roughly half of its credit card receivables and used part of the proceeds to fund a massive share buyback program that is currently in progress. Unfortunately, the tough economic environment has led to depressed real estate values and increased loan losses have caused a lower valuation of its credit card division. As a result, it is likely that Target will have to wait until the market improves before taking any additional actions.

So, just how much is Target worth? Ackman has stated in past filings with the SEC that he believes shares could be worth upwards of $100 a piece if the real estate and credit card portfolios were monetized and shareholder value was unlocked. While the market has turned for the worse, substantial value may still exist in these assets as Target continues to trade at cheap multiples. Currently, these multiples value the company at just $37.8 billion and just 15x earnings.

Investors looking to take advantage of this opportunity may want to look at purchasing LEAPS. The January ‘10 $50 at-the-money LEAPS are currently trading at around $10.50. This means that investors are expecting Target shares to hit $60 a piece during the next 477 days, while the January ‘11 LEAPS suggest a $63.70 price tag over the next 848 days. These prices could represent great deals if Ackman’s prediction of $100+ per share materializes over the next year or two.

LEAPS also provide downside protection in that investors only lose the $1,050 premium paid for the options rather than risking more than $5,000 to purchase the underlying shares. So, if shares decline more than 20% then the trade-off makes sense for the LEAPS option. Furthermore, enterprising traders can even write calls on the LEAPS position to create a diagonal spread to make up for a lack of a dividend!

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