One of the key macro themes underway is that even after employment and wages recover consumers will remain significantly more price conscious relative to attitudes seen over the prior three decade spending boom. Given this trend, I believe The TJX Companies (TJX) is the best positioned apparel retailer to benefit from a secular shift in consumer preference for greater value.
TJX is the leading off-price apparel and home fashions retailer with revenues that are almost three times as large as its nearest competitor, Ross Stores (ROST). The company sells a wide selection of brand-name and designer merchandise at low prices, generally 20% to 60% below department and specialty retail stores, providing customers with both quality and value. TJX's target customer is female, middle to upper-middle income, between the ages of 25-54 years, and fashion and value conscious.
Despite its low-price strategy, TJX generates incredibly high ROIC averaging 30% over the past decade. These high returns are due to the company's low-cost structure and solid revenue growth. As a result, TJX has generated significant free cash, which management has used to reinvest in new store growth and to provide value to shareholders through share repurchases (11% 10-year CAGR) and dividends (21% 10-year CAGR on a per share basis). TJX also has one of the strongest balance sheets in the industry positioning it to gain share and generate strong profitability in challenging economic environments, such as the current one.
Competitive Advantages Provide Economic Moat
TJX’s competitive advantages include a highly experienced merchant organization, extensive relationships with vendors, and a highly efficient distribution network. Its merchant organization of over 700 employees purchase inventory at discounts to initial wholesale prices from over 14,000 vendors. Merchants purchase “close to need” enabling them to buy into current market trends. Thus, TJX has greater flexibility in adjusting prices to meet market demand. This strategy also enables the company to turn inventory more quickly versus traditional retailers, which order goods far in advance of the time the merchandise is actually placed on store racks. Store merchandise is refreshed frequently through TJX’s highly automated distribution network. TJX's vendor relationships and infrastructure have taken decades to create. Thus, I believe it will be difficult for existing and future competitors to replicate TJX’s business model to the scale that the company is currently operating.
Proven Track Record TJX has a long track record of growing its business through challenging economic environments and maintaining share gains post-recessions. The company generated solid same store sales growth in each of the prior four recessions, with only one year of negative same store sales (FY96) in the last 35 years. TJX generated positive comparable store sales during the Great Recession with growth in both FY09 (+1%) and FY10 (+6%) driven by higher customer traffic, which includes capturing new customers. I believe customers will continue shopping at TJX’s stores once the recession ends, which is consistent with the trend following prior recessions.
Operating margins have improved dramatically over the prior decade. I estimate FY12 margin at 10.6%, excluding restructuring costs, versus 10.0% in FY11. This compares to a historical 10-year average of 8.1%. I believe the current margin is sustainable over the next five years as management has made significant progress in managing cost of sales through a highly efficient merchant buying network and lean inventory management (total inventory turns have increased from 5.2x in FY08 to 6.1x in FY11). Further, last December management announced plans to close A.J. Wright, which had been a drag on margins. Finally, management has slowed expansion in Europe to focus on improving margins there, which are significantly below the U.S. and Canada. In FY12, TJX estimates a 3.1%-3.5% segment profit margin in Europe with the potential to grow this to over 8% in the coming years. This compares to margins in the U.S. and Canada which currently exceed 13%.
Significant International Growth Opportunities
Most of TJX's over 2,900 stores are located in the U.S., but expansion internationally is an important part of its growth strategy. Over the past 12 years, Marmaxx stores (U.S.), which includes T.J. Maxx and Marshalls, have grown total revenue at a 6% CAGR, while Canadian and European growth have averaged 17% and 22%, respectively. While I see continued growth in the U.S. (due in part to share gains during this past recession), I believe TJX has numerous opportunities to grow its stores internationally. The company currently has stores in Canada, U.K., Ireland, Germany and Poland. While there is room for new store growth in these existing foreign markets, I see significant long-term potential for TJX to expand into additional countries.
Historically, the company has generated high returns and I expect this to continue. ROE and ROIC have averaged 42% and 30%, respectively, over the last 10 years. Given the company’s long history of sustainable growth in revenue and margins, I expect it to continue to generate above industry-average returns for the foreseeable future. These returns have enabled TJX to return cash to shareholders. Total dividend payments have increased for 16 consecutive years (through FY12) and TJX has repurchased over $9B in shares over this period.
While TJX faces a highly competitive market, management has a proven track record of generating shareholder value. I see two main risks going forward. First, TJX faces execution risk with regards to its growth strategy overseas. The company stumbled last year due to poor execution in Europe. It has since reshuffled the local European management team and adjusted its branding and pricing strategy in the region. Second, operating margin expansion is likely limited going forward. It will be difficult for TJX to continue to improve inventory turns at the rate of the past few years, and margins will face some pressure as the company's sales mix shifts towards Europe.
TJX is a Core Holding
TJX shares have significantly outpaced my expectations, rising over 60% since first establishing a position in early 2010. With the shares currently trading at over $60, near-term upside may be limited. However, I expect dividends per share to continue to grow at double-digit annual rates. Additionally, the company's high ROIC and strong balance sheet should limit downside risk in this challenging investment environment.