- DCF analysis indicates that all future value to be derived from TJX companies is currently reflected in the share price. Selling to deploy the cash into better opportunities makes sense.
- I am not a stock collector. I try not to get married to any of my positions. TJX has served its purpose in my portfolio.
- Discounted cash flows analysis is the superior valuation methodology, as others inherently involve anticipation of market sentiment.
"Don't get married to a stock."
From what I could find online, this bit of investment advice can't be traced back to any one individual. Yet it is espoused by many, and remains one of the key tenets to my investment philosophy.
What does it look like to be "married" to an investment? Among other things, evidence of the love affair includes:
- Refusing to sell in spite of compelling reasons to do so
- Being willing to add to the position regardless of valuation
- Ad hominem attacks leveled at anyone who is bearish
- Ignoring data that indicate weaknesses in the company, and glorifying even mild positives. Confirmation bias.
This list is not intended to be all inclusive, but I imagine those of us who regularly peruse the comments section on Seeking Alpha articles see these things on full display on a regular basis.
Even though I try to adhere to the principle of not getting married to my stocks, I am not perfect. I have held on to my Carter's (CRI) position for probably far too long. I always seem to find a reason to hang on to see if my investment thesis plays out (currently I am waiting to see if a miniature baby boom results from the COVID-19 related lockdowns). I have held CRI for almost four years now with little to show for it.
With all that as a backdrop, the intent with this article is to explain why I have decided to sell my position in The TJX Companies (NYSE:TJX) even though I really love the company. They are well run and have a sound business model. Nonetheless, I believe that all future value to be extracted from the company is currently reflected in the share price. I am resisting emotional attachment, and plan on cashing in.
Discounted Cash Flows
I firmly believe that the best way to value a company is by summing all future cash flows and discounting them back to the present. Dividing by shares outstanding then provides an intrinsic value per share, the price at or below which shares should be bought and above which shares should be avoided. I try to run this exercise with all my holdings on a periodic basis to get a feel for where they ought to be priced vs. where the market is pricing them. That often leads to some actionable take-aways, which is what happened with TJX.
I input the following as it relates to cash generation:
1) 2021 sees revenue identical to 2019, a record year for the top line at TJX. This is generous considering that TJX still has some stores closed due to COVID related shutdowns, and they anticipate that they will lose 11% of their first quarter due to that. After 2021, revenue grows for 7.4% annually for four years, matching the compound annual growth rate they have had in the past ten years.
2) Cash from operations margin lands at 10% in 2021, slightly above their ten year average of 9.7%. Margins expand by 100 bps every year then-after for four years for a 14% margin in 2025. This is in context of their all-time record margin being only 11.7%, and that happened back in 2013.
3) CAPEX stays in line with their ten year average of 3.18% of sales.
4) Discount rate of 10%, the long term return of the stock market, which I assume most people aim to at least match.
5) Terminal growth of 3%.
Here is my worksheet putting all that together:
Under this scenario, intrinsic value is $62. The problem is that I don't see any feasible way where TJX can deliver these results and generate enough cash to support that $62, let alone the $64 they are trading at currently. The reasons for my doubt are:
1) Growing revenue at 7.4% annually, identical to what they have achieved historically, will be extremely challenging. For one, larger numbers are harder to compound at the same sustained rates. Furthermore, TJX has no plans to expand their store count in the foreseeable future at a rate similar to what they did in the past decade. In the 2011 through 2019 time period, TJX expanded their store footprint from 2900 stores to about 4500, an addition of 177 stores per year. Per their most recent conference call, after 122 net new stores this year, they are looking at long term growth of 60-75 net new stores opened annually. That is far below the 177 new stores opening every year that helped them reach the 7.4% sales growth from 2011-2019. The only way TJX can reach that 7.4% number is through sales growth at existing locations, with comparable store sales growth picking up the slack. This has been the cadence for comp sales in the period under observation:
|Comp Sales Growth||4%||7%||3%||2%||5%||5%||2%||6%||4%|
*Data compiled by author
Impressive numbers, to be sure. However, I dare say that these numbers will also be hard to replicate. With the cadence of their store growth slowing, more established locations will have to push stronger same store sales growth numbers, which becomes harder to do the longer a store exists in a given location.
2) There are no catalysts in place to push margins upward. Margins have floated around 10% for a decade. Getting them up to 14% would require something big and sustained to happen, something transformational for the business model. I don't see anything like that on the horizon. I see no reason for them to vary far outside the 10-11% bound.
Because I don't believe that TJX can generate the cash needed to justify the current share price, with not being able to grow revenue enough or expand margins enough, it makes sense to sell. Other investors have come to a different conclusion. I would caution against using overly simplistic methodologies as the sole determinant of intrinsic value, particularly those metrics that rely on human emotion for their derivation. The problem with the ever popular P/E ratio and all other such ratios is that their very construction includes a component, price of course, that is wholly reliant on the emotions of the masses. Limiting the role of emotion in investing is always wise. Similarly, basing valuation and subsequent buy or sell decisions on current dividend yield when compared to historic averages is likewise risky, for the same reason. Yield is a function of price, and price is determined by thousands of emotional people acting in the stock market. It is popular to say something like "the dividend yield at TJX is higher than their historic average, and if they revert back to their 5-year average yield that will result in share appreciation of such-and-such percent". While mean reversion is real, the mean changes over time. And it should. It must, because business conditions change over time and so do companies. But those changes happen unpredictably, might go in either direction, and can be swift. What many might consider to be a temporary multiple collapse might in fact be the new mean a few years down the road, meaning a flat return at best, forever waiting for a reversion to some past mean. It is for this reason that a DCF analysis is a superior way to value companies. Ratios and dividend yields can inform one's analysis, but ultimately the worth of a business can only ever be based on how much cash it can generate.
Let me be extremely clear: I am absolutely not suggesting anyone short TJX. There are no catalysts in place to push the stock price down, and TJX is a fundamentally sound business. And while their valuation is high in my estimation, it is not so high that a multiple collapse is imminent. Not only that, but there are a few things that could even send the share price up in the short term. First, about 15% of their stores are still closed due to COVID-19, most of them in Europe. News breaking about these stores re-opening will likely prop up the shares, and subsequent revenues from the same will help deliver good results in coming quarters.
Second, COVID-19 related shutdowns caused some retailers who share similarities with TJX to go out of business. A few examples include:
- Stage Stores (Gordmans, Bealls, etc.) which had 800 stores throughout the U.S.
- Pier 1 Imports, which had 900 stores across the country
- Tuesday Morning, also a discount retailer, had 700 stores
- Off-price department store Stein Mart, which had 281 locations
There are others. TJX stands to be a prime beneficiary of the holes these retailers left in the economy, and they could capture considerable market share.
Third, and related to point two, the harsh economic environment has opened up some real-estate opportunities for TJX. They spoke to this on the conference call:
.... we’re prepared to take advantage of the terrific real estate availability that we are seeing across each of our geographies and continue our global store growth. With the increase in store closures by some other retailers, we are in an excellent position to open new stores in some of our target markets. Further, we see additional opportunities to relocate existing stores to more desirable locations, and to seek out more favorable terms when leases expire.
All these positives working together could result in earnings surprises in coming quarters, which might advance the shares. I am still extremely skeptical that those surprises will be enough to justify the stock price on the basis of discounted cash flows. But the reality is that not everyone in the market uses a DCF analysis to make buy and sell decisions. Things are often driven by analyst estimates and whether or not those estimates are beat, even if the estimates themselves were low. There is plenty that could drive the share price of TJX way beyond where it is now. But the crux of my argument is that these drivers may occur in the absence of the cash flow generation needed to satisfy my required rate of return. It is for this reason that selling makes sense to me.
I have two batches of TJX stock. The first was purchased back in December of 2017 when it was trading around $37. Trading now around $64, that's a 20% annualized return vs. 14% for the S&P over the same time frame. I bought the second batch when shares revisited the mid $30's during the pandemic stock market collapse. Annualized return since then is 82% vs. 74% for the S&P. Those returns are phenomenal. But the returns alone aren't the reason I am selling. Selling due to a fantastic return, or "cashing in", is almost never a good reason to sell by itself, at least for young investors. No, I am selling because the data is clear that the current stock price of TJX is too high to be supported by a realistic or even generous appraisal of future cash flows. I believe that TJX will stay in the $60-$70 range for many years. I don't predict a big crash in the stock, simply because the company is so good. But it won't see strong upside either. They can't grow fast enough for that. So my money will be better deployed into other opportunities. Perhaps instead of completely liquidating, I am considering selling my first batch only, which I did on Monday at $67 a share. That is the batch most prone to not meeting my required rate of return of 12% annually if any retreat in the share price does happen. I can hold on to my second batch and see if A) I get lucky and can juice more returns out of it by letting my winner ride or B) hang on to it as a dividend growth opportunity. I am absolutely going to sell TJX, but perhaps only half. I would get interested again if shares dipped below $50.
Allow me to end with where I began: marriage. A peculiar thing I have seen is for people to feel like they can't sell a stock because it has been so good to them. It is almost as if they would feel like they are betraying it by selling. Let's not lose sight of a big reason why investing even exists. That is, to make money. If money has been made on a position and it can't be reasonably expected to return much more based on accurate appraisals of future cash generation, then sell. Especially if there are better places to allocate that capital. Buying stock isn't matrimony, and emotion is the enemy to investing.
This article was written by
Analyst’s Disclosure: I am/we are long TJX. 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.
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