TJX Companies (NYSE:TJX) Investment Considerations
TJX Cos is a leading off-price apparel and home fashions retailer in the US and worldwide. The firm believes its business model is one of the most flexible in the world and that it has one of the broadest demographic reaches in retail. TJX Cos was founded in 1956 and is based in Massachusetts.
Over its nearly 40-year history, TJX Cos' annual same-store sales have declined only one time, and it has delivered strong earnings expansion and some of the highest financial returns in the retail sector. We love its ValueCreation rating.
Driving traffic and same-store sales growth will be the biggest growth driver for established TJX Cos. The firm believes it has huge opportunity to gain even more market share by attracting younger customers and leveraging its global marketing strategy through an integrated approach that includes growing its e-commerce presence.
TJX Cos has a lot of things going for it. The company's outstanding values, interesting mix of apparel, and home fashions are resonating with shoppers across its geographies. Customer traffic continues to be the primary driver behind strong comp performance.
Fiscal 2016, ended January 31, was a strong year for TJX Cos. The firm reported net sales growth of 6%, driven by comparable store sales growth of 5%. Diluted earnings per share rose a solid 5% compared to fiscal 2015 as well. The year marked the company's 20th consecutive year of comparable store sales and earnings per share growth.
The company remains confident in its ability to grow to be a $40 billion company, a feat we think is achievable given the firm's track record and solid recent top-line trends.
Economic Profit Analysis
In our opinion, the best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital with its weighted average cost of capital.
The gap or difference between ROIC and WACC is called the firm's economic profit spread. TJX Cos' 3-year historical return on invested capital (without goodwill) is 62.8%, which is above the estimate of its cost of capital of 10.6%. As such, we assign the firm a ValueCreation™ rating of Excellent.
In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Companies that have strong economic profit spreads are often also solid free cash flow generators, which also lends itself to dividend strength. TJX's Dividend Cushion ratio, a forward-looking measure that takes into account our projections for future free cash flows along with net cash on the balance sheet and dividends expected to be paid, is an impressive 4 (anything above 1 is considered strong).
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. TJX Cos' free cash flow margin has averaged about 7.1% during the past 3 years. As such, we think the firm's cash flow generation is relatively STRONG.
The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. At TJX Cos, cash flow from operations decreased about 1% from levels registered two years ago, while capital expenditures fell about 7% over the same time period.
In fiscal 2016, TJX reported cash flow from operations of ~$3 billion and capital expenditures of ~$900 million, resulting in free cash flow of just over $2 billion, representing a ~2% decrease from fiscal 2015.
This is the most important portion of our analysis. Below we outline our valuation assumptions and derive a fair value estimate for shares.
Our discounted cash flow model indicates that TJX Cos' shares are worth between $50-$82 each. Shares are currently trading at ~$75, in the upper half of our fair value range. This indicates that we feel there is more downside risk than upside potential associated with shares at this time.
The margin of safety around our fair value estimate is derived from the historical volatility of key valuation drivers. The estimated fair value of $66 per share represents a price-to-earnings (P/E) ratio of about 21 times last year's earnings and an implied EV/EBITDA multiple of about 10.7 times last year's EBITDA.
Our model reflects a compound annual revenue growth rate of 6.4% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 7.8%. Our model reflects a 5-year projected average operating margin of 12.9%, which is above TJX Cos's trailing 3-year average.
Beyond year 5, we assume free cash flow will grow at an annual rate of 3.9% for the next 15 years and 3% in perpetuity. For TJX Cos, we use a 10.6% weighted average cost of capital to discount future free cash flows.
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $66 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values.
In the graph above, we show this probable range of fair values for TJX Cos. We think the firm is attractive below $50 per share (the green line), but quite expensive above $82 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate TJX Cos' fair value at this point in time to be about $66 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart above compares the firm's current share price with the path of TJX Cos' expected equity value per share over the next three years, assuming our long-term projections prove accurate.
The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change.
The expected fair value of $87 per share in Year 3 represents our existing fair value per share of $66 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Wrapping Things Up
TJX Companies believes its business model is one of the most flexible in the world and that it has one of the broadest demographic reaches in retail. Over its nearly 40-year history, TJX Cos' annual same-store sales have declined only one time, and it has delivered strong earnings expansion and some of the highest financial returns in the retail sector.
The company remains confident in its ability to grow to be a $40 billion company, a feat we think is achievable given the firm's track record and solid recent top-line trends. TJX Cos recently increased its quarterly dividend by 24%, and its Dividend Cushion Ratio of 4 suggests that the company can support its increased payout with plenty of room to spare.
Though we are high on the dividend growth potential of TJX, we'd prefer to wait for a better entry point to establish a position in the firm. TJX Companies currently registers a 6 on the Valuentum Buying Index.
Disclaimer: This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.