- TJX proves critics wrong this quarter.
- Margin contraction argument has some heft but also has some offsetting factors.
- Continue to prefer TJX over Ross Stores.
A few months ago, I had valued TJX (NYSE:TJX) at $90 while arguing that it was a bargain relative to Ross Stores (ROST). So far the market hasn't agreed with this assertion, but I think we are getting there. TJX was up 7% yesterday after an impressive earnings result that included a consensus-beating guidance. Comps were up 4% in the fourth quarter, proving that flat comps in the previous one was just an aberration and customers are still totally into the "buy now or cry later" treasure hunt atmosphere.
TJX 4Q Earnings Analysis
Net sales in the quarter surged 16% to $11 billion, but there's the effect of an additional week built into that rise. A 4% comp (which excludes the effect of an additional week) is still exceptional when one considers the intensifying off-price competition and the base at which TJX is operating. Ross Stores generates only about 37% of TJX's revenues. Therefore, anything less than a 4% comp in its upcoming earnings could mean that the firm could have lost share in percentage terms.
Segment margins contracted ~80 basis points to 12%. TJX attributed the margin contraction to unanticipated freight costs resulting from driver shortages. The freight problem was widely reported in January so I initially did not see this as anything out of the ordinary.
But after reading the transcript, I feel there is definite concern about TJX's margins especially when you look at some of the downgrades this year. The rationale is that attempts by departmental stores to scale their off-price operations should crimp margins at companies like Ross Stores and TJX. Scale, after all, is crucial for success in this business. Ross Stores as the single largest brand has the highest margins, followed by TJ Maxx and Marshalls which are both owned by TJX. This establishes the scale vs. margin correlation.
Additionally, departmental stores are also a source of merchandise supply. They could use at least a part of this supply to fuel their own off-price concepts. But then on the channel side, the company mentioned that online retailers have created additional supply offsetting the decline from departmental store merchandise. At this stage, I think there are offsetting factors in place for every headwind. Therefore, I am maintaining the 11.5% operating margin assumed in my previous piece. As against a 3% CAGR in revenues, I have assumed a higher rate of 4% until 2019 considering that the company is still expanding its store count and has guided comps at 1-2%. The only other assumption that was not considered previously was the reduction in share count by ~5%. This obviously is a direct consequence of the newly approved $2.5 billion-$3 billion share repurchase program.
Both TJX and Ross Stores have a business model that makes consumers weak when they have been painted as omnipotent by other chains in the apparel industry. My assertion that TJX is a bargain is purely on the pricing-valuation gap comparison between the two companies. This gap seems wider in the case of TJX. I therefore think its upside to downside ratio is favorable enough to constitute a safe accumulate even at the $82 price level.
Company related data sourced from Investor Relations.
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