Tuesday, June 4, 2013

Why TJX Companies Remains Good Value

The retail sector has been one of the hardest to call in recent years. The bifurcation in prospects between the haves and have-nots in the U.S. has created an atypical situation within the sector. Whereas in previous recoveries, the general drift is upwards across the board, this recovery has seen a strengthening at the high end and a general movement towards ‘trading down’ in the mid range. Within these shifting sands, one island of retail has offered strong prospects.

Specifically, the off-price retailers have demonstrated continued strength and The TJX Companies’  latest results are confirming this trend.

TJX Companies reports sales growth at the high end

Earlier in May TJX Companies had reported same-store sales growth of 2% in the quarter and declared that its same-store sales in April came in at the high end of guidance at 8%. This positive trend appears to be in place as the company declared that its May sales were off to a ‘strong start.’

As ever with TJX Companies, it is worth noting that its guidance tends to be conservative. I discussed this issue at more length in an article linked here. In rote like fashion, its management tends to guide towards 0%-2% in same-store sales growth. However, they came in at 2% for this quarter and the guidance was 2%-3% for Q2. All of this makes it rather surprising that it kept its full year guidance at 1%-2%. Upside to come?

I’ve broken out the revenue trends within its segments.




And in order to see how TJX makes its money, here is a breakdown of its segmental profit for the quarter.




Clearly, it is still largely a story of Marmaxx (T.J. Maxx and Marshalls) and its prospects are largely guided by the retail movement towards trading down. TJX is not alone in this. Indeed, Ross Stores has benefited from exactly the same trends. Furthermore a retailer like Nordstrom is expanding its lower priced Rack stores in order to react to the new retail reality. I’ll come back to these companies in a moment, but for now I want to look at some of the interesting other growth drivers that TJX has going for it.

TJX Companies’ other growth prospects

While the reliance on Marmaxx is well understood, TJX has some interesting growth drivers going forward

  • Europe presents significant growth prospects. The competition in the off-price market is a lot less and Europe’s economic difficulties are creating growth opportunities. The U.K. has long been a strong market for TJX, but Germany was cited as doing ‘very well’ with the potential to expand to 350 stores from 50 at present.

  • Home goods in the U.S. have the potential to grow in line with the recovery in the housing market. Its segmental margins increased 120 bps in the quarter and the opportunity to cross sell home goods to its clothing customers is significant. It is the right category at the right time.

  • TJX also has growth opportunities from expanding its appeal to male and youth customers

  • It is launching a large scale e-commerce initiative in the second half of 2013, of which it claims to have made minimal assumptions within its growth projections.

Many of these plans have things in common with other companies in the retail sector. For example Coach  is trying to deal with the problem of rivals like Michael Kors encroaching on its affordable luxury market by focusing on non-core categories for its growth. In particular, its initiatives in footwear, apparel, and men’s categories are a recognition that retail outlets need to be innovative in developing new revenue streams. In common with TJX Companies' plans to target men, Coach is trying to tap into the growing market for male fashion and grooming.

Similarly, Nordstrom’s collection of growth plans center on expanding its e-commerce, in-store mobile point of sale devices, and Rack stores; all of which requires significant capital expenditures (around $3.7 billion) over the next five years. It is an ambitious plan and adjusting to the new retail environment is the right thing to do, but investors need to be confident in its execution.

Where next for TJX Companies?

The stock has had a nice run and I note some profit taking after the results. I like the stock and have a target price in the mid $50’s. Analysts expect double-digit earnings growth for the next couple of years and I like its long-term earnings prospects from the growth drivers discussed above.

A forward PE of around 18x may appear expensive, but it has converted over 140% of its earnings into operating cash flow on average for the last three years. Its business model is cash generative and it has good growth prospects. If it can generate another $2 billion in free cash flow this year, this would put it on a forward free cash flow yield (as I write) of 5.4%. That’s good value for its long-term prospects.