TJX: This Fast-Growing Retailer Might Offer Some Recession Tolerance To Your Portfolio (Long Term)

| About: TJX Companies (TJX)

Summary

TJX is a competitive off-price retailer with low sales sensitivity to economic downturns and a rather stable (yet strong) sales growth.

While the inventory-to-sales metric is on the rise in the retail industry, TJX's business model is favourable for high inventory turnover and has a positive impact on the margins.

The company has a clean balance sheet and a significant long-term potential.

TJX might be viewed as a compelling short-term holding (with medium risk). The stock might be also viewed as a low-risk holding if bought at a lower valuation.

Overview

It is not all doom and gloom in the retail industry. Even though most of the famous names of the industry are not having the best of times, consumers cannot cease to buy things on a daily basis. Retail sales are still reasonably strong. What is changing, however, is the retail business itself.

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Brick-and-mortar vs. the Internet

Despite having numerous advantages, Internet-based sales predominantly attract new customers because of the speed, convenience and lower prices associated with shopping online. Even though the company under the focus of this article does not concentrate on digital sales, its performance in physical sales is worth mentioning.

Because of a skeptical view on the current state of the stock market, I am neutral-to-bullish on the stock for the nearest term. However, I currently view the stock as an attractive long-term holding if bought at an attractive price.

TJX

The company, TJX Companies Inc. (NYSE:TJX), specializes in off-price retailing. Its own description of this concept immediately points out the certain advantages of the business: high inventory turnover and reasonable margins.

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Source: Company's Presentation (2015).

The company has more than 3,300 stores in 7 countries and operates 3 e-commerce websites:

  • U.S.: T.J. Maxx and Marshalls (Marmaxx), HomeGoods and Sierra Trading Post, as well as tjmaxx.com and sierratradingpost.com.
  • Canada: Winners, HomeSense and Marshalls (TJX Canada).
  • Europe: T.K. Maxx in the United Kingdom, Ireland, Germany, Poland, and Austria, as well as HomeSense and tkmaxx.com in the U.K. (TJX Europe).

The thesis

Over the last 15 years, the company has experienced a tremendous run-up in its share price, and not without a reason. Since 2007, the company has managed to grow its revenue at a CAGR of 6.6% with no downturns on an annual basis. A performance chart for TJX, S&P 500 as represented by SPY (NYSEARCA:SPY) and XRT (NYSEARCA:XRT), an S&P retail ETF, follows. All starting values equal 100.

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Source: made by the author using Yahoo Finance data.

The above-mentioned revenue growth has had a strong impact on the stock's performance during the bear market of 2007-2009. A safe haven or not, the company's profitability was not strongly impacted by the Great Recession over the short term, which made it quite tempting to hold the shares of a more-or-less stable money-maker while watching other market darlings fight the margins amid falling sales. Whether the stock is capable of handling the market volatility this time or not is the question I am studying throughout this article.

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Source: made by the author using Yahoo Finance data.

Interestingly enough, the current situation is to a certain extent reminiscent of the one that was present in 2007-2008. Stock's correlation with the S&P 500 has been edging lower recently, yet it remains strong with the retail sector, which can be easily seen in the chart below.

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Source: made by the author using Yahoo Finance data.

The stock's latest performance might indicate a rather bullish sentiment. However, even though the Money Flow Index looks healthy for the TJX's bulls, the number of decreased active positions among the institutional holders of the stock demonstrates a net outflow which is not balanced out by a net inflow among the opened/closed new positions (this should be paid more attention to after the next earnings release). Insiders have also been somewhat net bearish over the last 3 months, it turns out.

Competitive edge

The way the company's strategy ensures sales growth is impeccably described on HomeSense website, the company's U.K. homeware chain.

  • "At HomeSense, we deliver great value on ever-changing selections of branded and quality homeware and gifts from around the world, at prices up to 60% less than the RRP and at a significant discount to the prices in a department store or on the high street."

The company's approach for choosing its assortment is to a certain extent close to that of the value investors when picking stocks, which is greatly appreciated by the customers.

  • "For us, value is a combination of brand, fashion, price and quality. […] We're smart shoppers, just like you."

The company is differentiating itself with a strong (and sometimes quite aggressive) focus on its clients.

  • "Unlike traditional retailers, we generally don't do promotions, sales, or other gimmicks. […] Our stores are as flexible as we are. We have no walls between departments, so we can easily expand and contract merchandise categories to respond to the newest trends and changing customers' tastes."
  • "Some of our online competitors offer 'free' shipping. But is it really free? The fact is, all companies incur shipping costs and frequently inflate the prices on their merchandise in order to cover those costs. We prefer a more straightforward approach. Our prices reflect the great deals we've negotiated" - from Sierra Trading Post website.

Low focus on digital sales: a competitive strategy or a future iceberg?

It is a good sign that the company is capable of maintaining strong revenue growth via physical (brick-and-mortar) sales while the retail industry is on average struggling. However, is the company capable of ensuring that it is not going to become another victim of the Internet? Even though the company is putting much effort into making its websites as modern and rememberable as possible, it is not exactly clear why most of the TJX's businesses do not sell on the Internet, as it is still 3,300+ stores vs. 3 e-commerce websites (which only operate country-wide). Influence of the largest Internet retailers (this is only a hypothesis) makes most people expect to see the most attractive deals on the Internet, not in the brick-and-mortar stores. (1) Speed, (2) ability to compare, (3) ability to shop from any location and (4) unwillingness to sacrifice the time required to visit a physical store in case the purchase is not being made are the factors that have an impact as well. The company is strong at and is putting much emphasis on keeping existing clients, as most of its websites are primarily focusing on three basic things:

  • Making an impression.
  • Showing the customer his/her way to a store.
  • Keeping the customer via offering a discount/gift card.

However, even though the company is undeniably bullish on its expansion (and is stating specific number of stores it expects to see for its various businesses in the long run), the market is changing, and the company needs to ensure that the customers want to visit a store, which might potentially break the rule of only shopping online for some of them (which is becoming less and less rare with each day). The U.K. T.K.Maxx and the U.S. Sierra Trading Post websites clearly demonstrate that the company can, in fact, sustain its customer-friendly atmosphere on the Internet (I was not able to access the U.S. T.J.Maxx website from my country).

Just as retail investors like the shares of Google, the search giant, modern retail customers like searching and browsing, and the more social media influence there is, the more time is being spent on scrolling the news feeds, which can easily become a habit and could be replicated by e-store browsing (not to mention the related decreased time availability).

To sum up, even though the company is doing a great job with its physical sales, the lack of a stronger digitalization of the company's businesses makes me view the future growth potential with a certain degree of skepticism. Even though such developments (1) can potentially cannibalize the company's physical sales and (2) might be not entirely appropriate for the company's homeware segment, the current pace of physical sales growth cannot be sustained for too long. The company is reasonably good at digital sales, and any digital expansion would most probably act as a notable long-term catalyst for the stock. Even though it is still possible to argue that the company actually gains from selling more via the brick-and-mortar way, it is hard to deny that off-price retailing business model is greatly suitable for digital sales.

From the company's website: "Beyond our successful brick-and-mortar business, we continue to view e-commerce as an important driver of future growth for TJX. E-commerce gives us another platform to reach even more consumers with our great values, offering them the ability and convenience to shop 24 hours a day, 7 days a week."

Where is the growth coming from?

The company's top-line has been nearly recession-proof.

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Source: Company's Presentation (2015).

As mentioned before, the business model allows for a high inventory turnover, which makes the company quite flexible when it comes to the changes in the market. From the 2009 annual report:

2009 has not been a disappointing year for the company:

  • Net sales of $19 billion, +4% y-o-y (with new stores being a "significant source of sales growth").
  • Same store sales +1% y-o-y (with an increase in customer traffic and an overall decrease in average transaction values).
  • Cost of sales and SG&A expenses up by only 0.3 and 0.1 pp, respectively (as a percentage of net sales).
  • Consolidated average per store inventories of continuing operations down 6% y-o-y.
  • In 2008-2009, the company was cash flow negative due to the share buybacks (even though the operating cash flow was in a reasonably good condition).

After facing the recession, the company continued its expansion as if nothing happened (except the data breach scandal of 2007). Total number of stores has increased by 36 percent since the end of FY 2010.

Source: made by the author using the data from annual reports.

However, despite the rapid expansion, not much has changed since 2009. The company is still starkly dependent on the U.S. as it remains a major contributor to its revenues.

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Source: made by the author using the data from annual reports.

The majority of the company's revenues is coming from apparel and footwear (55%), homeware (30%) and jewelry and accessories (15%). For a retailer, TJX's margins are quite impressive:

  • Marmaxx: 14.3% (+4% same store sales growth in FY 2016).
  • HomeGoods: 14% (+8% same store sales growth in FY 2016).
  • TJX Canada: 13.1% (+12% same store sales growth in FY 2016).
  • TJX International: 7.5% (+4% same store sales growth in FY 2016).

Even though the company-wide margins have not been as solid, there has been a notable improvement over the years.

Source: made by the author using GuruFocus data.

On a less positive note, company's expenses have increased significantly in FY 2016, which might be an issue in case the U.S. economy suffers a downturn before TJX cuts its costs as it did during the Great Recession.

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Source: 10-K for FY 2016 of TJX Companies, Inc. (2016).

Are the company's financials as good as its growth is?

  • Current assets (31% of which are in cash) cover the company's total contractual obligations for the next 5 years and beyond.
  • The company has relatively low debt and did not issue any long-term debt securities during FY 2016. However, the company's financial position can significantly deteriorate in the case of an economic downturn. At the end of FY 2009, the company had a Debt/Equity of 1.89, which has already fallen to 1.58 by the end of FY 2010.
  • Share buyback program has been a strong drag on the company's cash generation of late. With a strong operating cash flow, in case of a dire recession (I am not suggesting that one follows shortly) the company has an option of strongly improving the cash flow generation by (1) ceasing the buyback, (2) cutting SG&A expenses and (3) slightly decreasing the CAPEX (as it would be logical to decrease the pace of expansion amid falling sales). However, I would not expect the company to stop its buyback, as it did not introduce such measures during the Great Recession.

Negatives

  • Even though the company was ranked #1 within the specialty retailer category on Fortune's Most Admired Companies list in 2016, Glassdoor reviews are often negative on the company's store-level management and express strong concern in the career development opportunities at the company. For as long as the company needs to attract new talent in order to continue identifying customer trends and preferences (as it writes in its latest 10-K), this might be a significant issue due to the employee rotation.
  • The company does not have full flexibility when it comes to closing stores due to the lease agreements: "We lease virtually all of our store locations, generally for an initial term of 10 years […] While we have the right to terminate some of our leases under specified conditions, including by making specified payments, we may not be able to terminate a particular lease if or when we would like to do so. If we decide to close stores, we are generally required to continue to perform obligations under the applicable leases…"

Q1 FY 2017 results

The company reports its next earnings on May 17, 2016. The following metrics are of paramount importance to watch:

  • Same store sales growth (particularly in the U.S.) - does the company grow in its key market? Is it a good timing to continue the expansion?
  • SG&A expenses and cost of sales - how much cost-cutting flexibility does the company have at the moment? The company expects higher SG&A during the FY 2017 and plans to have an SG&A/Sales margin of 17.8-17.9 percent due to the wage incentive.
  • Operating cash flow and cash flow generation - does the company continue to produce cash as efficiently as it has been before?
  • Any signs of additional incentives focused on the growth in the area of digital sales - does the company put enough effort into tapping the potential of Internet sales?
  • The previous 3 earnings releases (released before the markets open) have been followed by a strongly positive price action.

Conclusion

  • The business model is sustainable and makes the company strongly competitive. Client-oriented approach is paying off and will most probably act as a strong contributor to the customer retention rate over the long term. TJX has a relatively low debt burden and no significant issues with its financials.
  • The stock might be viewed as a compelling holding for the investors retaining a long-equity exposure over the short term. It is still strongly vulnerable to market movements, however, which only makes it a reasonable long-term holding if bought at better price and valuation levels. TTM P/E was below 10 in 2009, which is in a stark contrast with the today's value of 22.16. Even though the company might still appear overvalued from the book value perspective, low intangibles should be taken into account. For as long as its financials are in a good shape, it is mostly the company's reputation, supply chain and value-shopping skills that matters in TJX's case. From the Q4 2016 Earnings Call: "It is often underestimated how difficult it would be to try to replicate these strengths".
  • TJX has a long tracking record of increasing the dividend payment and currently has a dividend yield of 1.43%.

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.

Additional disclosure: This is not an investment advise. I am not an investment advisor.