Off-price Apparel Stock Picks: Citi Trends, TJX

Includes: CTRN, TJX
by: The Wall Street Transcript

On March 12, The Wall Street Transcript interviewed Patrick McKeever, a Senior Research Analyst at Avondale Partners, LLC on off-price apparel and dollar stores. Key excerpts, with his sector stock picks, follow:

TWST: What are you telling investors to do at this point?

Mr. McKeever: I continue to recommend TJX (NYSE:TJX). I've got a Market Outperform on TJX and a $33 price target. I continue to recommend it as the premier player within the space, and I think the space is fundamentally attractive. I think you'll see continued momentum at TJX, both on the top and bottom line as we go through 2007. I generally don't talk too much about valuation, but if you look at the multiple on TJX, the stock is currently trading 14.8 times my 2007 EPS estimate. ROST is at 17 times. Citi Trends (NASDAQ:CTRN), which is the most dynamic growth story within the subgroup, is trading around 22 times. So I think there is a valuation call to be made here on TJX.

I also think that the margin opportunity is still there for TJX. Yes, the company is coming upon some more difficult comparisons, and that is playing into the numbers to some extent. We got a 65 basis-point increase in operating margin in fiscal 2006. It went from 6.6% to nearly 7.3%. And I'm looking for a more moderate increase in fiscal 2007 of about 30 basis points. But I do see an opportunity for the company to continue to expand its margins through better buying and improving the performance at some of the newer divisions. I would also point out that TJX has been a great stock over the years, and part of this reflects the fact that the company generates some of the highest returns in retail. Their return on equity is in the high 30% area. They generate a tremendous amount of cash, as I mentioned earlier. I've covered this company for about five and a half years, and I think management has consistently acted in the best interest of shareholders over that time. So I continue to recommend that name, and I'd be taking advantage of recent weakness in the stock.

I have a Market Perform rating on Ross Stores (NASDAQ:ROST) and a $36 price target. Valuation is not my only concern. Ross is seeing some margin benefit right now from some things that happened over a year ago, including a big increase in inventory shrink that was detected in the fall of 2005. They are benefiting from that. They are benefiting from very easy comparisons. I'm not overly negative on the name - I'm just not willing to get behind it with valuation where it is and with my view that TJX is better positioned to capitalize on the strong industry environment and improved buying opportunities. I get out to the stores quite a bit, and I'm often struck by just how much better the merchandise looks at T.J. Maxx and Marshalls (MSLH) than it does at Ross.

Citi Trends remains my top pick among all of the stocks that I cover. I've got a Market Outperform rating on CTRN and a $54 price target. The stock right now is just below $40, but despite the valuation on this one, I continue to like it as the best growth story within my coverage universe. I would point to not only the square footage opportunity that I talked about earlier and the growth you'll see there over time, but also to the new store economics. The company's new stores will effectively pay for themselves in about a year.

The urban apparel space is very attractive and dynamic; you are seeing some nice growth there. The market for urban apparel is more than $10 billion, and it's growing at 30% or 40% a year. I think there are some positive demographic aspects to the Citi Trends story. Their core customer is the African-American consumer, and we are seeing some decent growth there in terms of population, but also with disposable income. The African-American consumer tends to spend more disposable income on apparel than the typical consumer.

For Citi Trends, I would look beyond valuation and look at the dynamic growth opportunity. This is your classic early-stage growth story within retail. If you look at classic early-stage growth retailers, the market tends to pay a premium for these names for a long time.