This week has been an interesting week to be in retail stocks. Dollar General (NYSE:DG) skyrocketed Monday on merger hopes. PetSmart (NASDAQ:PETM) soared today on earnings and sell-out rumors. And shareholders in discount retailer, TJX companies (NYSE:TJX) were rewarded on Tuesday with +8% gain after the company beat analysts' consensus estimates for revenues and earnings. As a value investor who had initiated positions in PETM and TJX earlier this year, I was naturally conflicted about the moves: thrilled at the capital appreciation, dismayed that I was losing the opportunity to buy more shares on the cheap. Still, even with the move up, TJX shares still look inexpensive in this otherwise fairly valued market, and I am marginally increasing my fair value estimate from $65 to $66, based largely on earnings visibility.
Investment Thesis and Recent Performance:
Possibly, as a result of the recent recession, off-price retail has grown at a remarkable pace over the past 5 years, growing at about a 10% CAGR compared to the 4% experienced by conventional retail. As one of the largest off-price retailers, TJX was already perfectly positioned to capitalize on this trend. Its lean and efficient inventory management system, focus on customer experience, and the global scale of its buying network both enhance customer experience and value while buttressing it against merchandising assortment risk and competition from e-commerce retailers. The company has shown remarkable resilience, posting consistent revenue and earnings growth over the past decade, with few hiccups even during the most recent recession.
Off-price retailers often outperform their more conventional rivals during economic downturns as consumers turn towards bargain shopping, but it is often thought that as economic conditions improve, consumers will trade back up to more expensive offerings. However, the slow pace of the economic recovery suggests that bargain hunting isn't going away anytime soon, and the gains realized by TJX and other discount retailers should be maintained even if the pace of economic recovery picks back up. TJX projects significant potential total store growth over the next several years, which could potentially expand its revenue base by almost two-thirds:
On the most recent earnings call, TJX posted results that exceeded management's previously stated expectations. Same store comparable sales increased across the board, with all segments posting around a 2-6% increase in sales on a constant-currency basis. Though growth rates for consolidated sales was off by about 100 BPS y/y, they were 7% higher on a sequential basis, and net income increased 8% y/y from $480 million to $518 million. The sequential increase was perhaps to be expected, as lingering weather effects holding down traffic in the first quarter disappeared and consumers appeared ready to make up for lost time. Margins remained solid, with gross margins at Marmaxx (15.3% vs. 15.1%), HomeGoods (12.2% vs. 11.8%), TJX Canada (13.7% vs. 13.4%), and TJX Europe (5.8% vs. 5.2%) all showing increases of 20-60 basis points. Management has previously pointed towards a goal of steady margin improvement in TJX Europe and HomeGoods to 10.1% and 13.1% respectively, and certainly, the company appears to be making good progress according to these metrics. Moreover, control of general expenses (SGA) fulfilled expectations, posting an 8.5% sequential decline, consistent with expectations. Overall, margin expansion and revenue growth were largely in line with my previous estimates, though revenues came in slightly above my expectations.
Second quarter store openings continued apace, with most of the growth occurring in HomeGoods (9 new stores, 200,000 additional square feet good for 1.7% additional sales area). All in all, the company continues to execute on its previously stated total store square footage goals in a predictable fashion. Inventories increased slightly by $200 million to $3.4 billion, a 5.5% per-store increase with new stores taken into account, though these were flat on a constant currency basis when excluding inventory in transit and online sales.
Based largely on current earnings visibility, TJX increased its guidance for the year to $3.10-$3.18. This implies continued moderate earnings growth year/year for H2'2014; management expects continued steady comps growth of 1-2%, in-line with this quarter's performance, and for margins to be in-line with historical rates.
I believe TJX has a wide and growing economic moat. The company focuses on rapid inventory turns, which are in turn sourced from a broadly based, global network of over 16,000 vendors, through 20 highly automated distribution centers. The company's excellent inventory management is highlighted by their focus on driving inventory turns from 12 to 13x, which compares favorably to its competitors:
Moreover, the company utilizes a proprietary inventory management system to better customize flow of merchandise to fit local conditions; in addition, its stores utilize an open floor plan to permit rapid expansion and contraction of individual departments to fit inventory needs. The company's philosophy of "the right merchandise to the right stores at the right times" serves to reduce its markdown exposure. TJX also leverages its scale (900 buying associates in 13 buying offices in 10 countries) to take advantage of pricing opportunities available in the marketplace, and typically offers merchandise at about a 20-60% discount to department and specialty store prices. The goal is to create a unique shopping experience, one that is not easily replicable by other retailers or even online sources, to drive repeat customers who are searching for their next big bargain find.
The company's focus on high inventory turns and unique, difficult-to-replicate shopping experience has yielded steadily increasing excess economic returns over the past decade, suggestive of an expanding moat:
Source: Self produced. 10-year financial data from Morningstar, historical price data from Yahoo! Finance, and Treasury yield curves from Treasury.gov.
Based upon current earnings visibility, and after incorporating this quarter's latest results and guidance into my model, I am increasing my fair value estimate from $65 to $66. I utilize a multi-stage discounted cash flow model informed by an analysis of trading multiples. I continue to project 1-2% same store growth in line with management expectations, and stable margins for Marmaxx and TJX Canada. As additional stores are built out, further leveraging the company's excellent inventory management system, I project slow but steady margin expansion for TJX Europe and HomeGoods, and predict overall profit margins to be about 12% by 2021. I expect earnings to accelerate even further by about 12% over the 10-year forecast period, as management continues with its aggressive share repurchase program:
TJX data by YCharts
I assume a cost of equity of 10% and use a weighted average cost of capital of 16% to discount projected cash flows. My fair value estimate implies a forward PE of 21 based upon a projected EPS for 2014 of $3.19, slightly above the upper bound of management's guidance. Projected data are reproduced below.
|Projected Cash Flows||2014||2015||2016||2017||2018||2019||2020||2021||2022||2023|
|Operating Cash Flow||$2,831,126,623.71||$2,984,217,886.69||$3,145,030,542.30||$3,271,981,712.14||$3,404,073,668.91||$3,540,236,727.13||$3,681,846,319.80||$3,829,120,307.64||$3,982,285,267.79||$4,141,576,842.44|
|Free Cash Flow||$1,027,487,783.60||$1,101,556,803.17||$1,186,207,057.47||$1,234,662,896.44||$1,285,160,475.72||$1,336,566,979.20||$1,390,029,767.63||$1,445,631,066.99||$1,503,456,434.20||$1,563,594,824.80|
TJX's recent performance mildly exceeded my expectations, and overall, the company remains on track to fulfill its long-term expansion and profitability goals. CEO Carol Meyrowitz has repeatedly pointed to the company's goal of becoming a $40-billion company, and certainly, as long as management continues to execute in this fashion, I see that as being entirely reasonable. My small increase in my fair value estimate suggests that there remains a material, though smaller, margin of safety in the shares after today's run-up. I remain very long TJX, and will look to accumulate more shares after prices consolidate.
General Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. The author is not a professional financial advisor. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions.
Disclosure: The author is long TJX.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.