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Ever have one of those situations where your logic, gut, and calculator all tell you different things? I’ve got that with TJX and off-price retailers. I think that’s the next shoe to drop in ’09.

I’ve been struggling with the analysis below for the past hour. The first chart shows the spread between the cash cycle for the apparel brands vs. the off-price retailers. As the brands profess to have found religion on inventory management, the cash conversion tightened between them and the off price retailers. Makes since due to meaningfully less inventory built up in the system. Then the second chart shows that there is a 0.57x relationship between changes in this cycle and EBIT margins for off-price retailers such as TJX and Ross Stores. The simple conclusion? That cash spreads have inflected, and as they build it is a positive for the off-price retail channel.

I don’t buy this.

I’m absolutely not being contrarian for argument’s sake. But I simply don’t think that the past seven years are an appropriate gauge of the relationship between off price retail and the rest of the supply chain. The past seven years were golden. Even the worst of the worst could make money. Strong consumer spending, $4bn+ in annual sourcing dollars injected into the industry, FX tailwind, etc… The number of apparel/footwear retail bankruptcies was less over the past seven-year period than at any other time in history. But this is a New Reality. The bankruptcy rate has started to tick up – and will do so much more meaningfully in 2009. Fans of TJX will tell me that this means better inventory for TJX. I say that this means that a new off-price retail channel will be created where one previously did not exist as legacy stores go bust. The magnitude of excess inventory will be too much for the existing off-price channel to bear.

With this channel currently running near peak margins (see Exhibit 2), there’s not a whole lot of room for error.