We added TJX to our short list last week. Here’s why.
To be clear, this is not one of those ‘accounting game’ or ‘structurally broken’ calls like KSS. But rather that this is a name known as having the best management team in retail that is at the end of its dominance in a part of the business that benefitted the most from a 25-year paradigm change in the way Americans/Canadians consumer apparel. Management is good, but even a mediocre team could have done well in a space like this (i.e. Ross Stores). Estimates are assuming 3% growth in perpetuity with ‘extend the trend’ margin assumptions (ie zero erosion in a share-losing reflationary environment). AND at this valuation the market arguably thinks that those estimates are beatable.
- GM near 29% --very stable since we emerged from the Great Recession, but before then this was a 24% GM business – and I don’t know what’s fundamentally changed.
- The internet is becoming the new clearance channel – and TJX has little competitive advantage there. No more outlet malls are being built. People will think this is bullish for off-price – less supply. But it’s not. The incremental off-price capacity is coming from incumbent B&M stores and online. Online, as you know, is margin dilutive but it has ‘implied’ infinite sales productivity. TJX e-comm is only 1% of total, and won’t head higher without diluting margins. If e-comm goes up, then the impulse purchase goes down.
- In a reflationary environment (which we’re in after 25 years of being deflationary) the poorest positioned companies are those that sell high-velocity products at lower prices. After the Basics apparel category, you have virtually everything that sells in a TJ Maxx. We are at 83 units of apparel per consumer every year – that doubled over 25 years. I kid you not. That happened as import quotas lifted, Warren Buffet was done buying North Carolina factories, and China took share from 3% to 39% of our consumption. Quality went down, price went down even more. Now as we experience reflation, we don’t just see margin cuts, as most people think, but rather we see slower velocity of units. Let’s say 70-75 per capita. People will under no circumstances buy more units of a apparel simply bc price goes up. #elasticity matters.
- In that scenario, we simply see deteriorating flow of product through TJX – and it probably loses its low cost advantage – especially given that the internet (as opposed to that strip mall 10 miles away where TJ is located) will become the new destination.
- TJ’s strip malls are being marginalized. There are 6,600 strip malls today – there was only 1,000 20 years ago. New strip growth should accelerate – and the anchor will likely be a 250k square foot Amazon store. They’ll likely get paid to occupy the space. Other tenants – incl TJX will likely get jacked.
- The street is only looking for 3% comp store sales for 3-years. But why should it be positive if velocity slows? Even if the consensus is right, the company can’t sustain a 29% merch margin on just a 3% comp. IF the Street is right on comp, it will be too high in gross margin. In other words, we absolutely need to see the company beat, McLean can’t justify modeling that (nor can I).
- Why need better than 3% comp? average lease duration is only 6.5 years. That’s quite low, and is definitely the ‘good guy’ move from an accounting perspective. Keep in mind that TJX leases virtually all of its stores. KSS, for example, has a 23 year duration – which is ridiculous as it is making bets on a consumer that hasn’t been born yet. TJX could always push out it’s duration as sales slow – in order to take down comp hurdle rate. But I think this is too much of a ‘stand-up’ mgmt team to do that. Keep in mind as well that leases come back on balance sheet in 2018.
Ultimately, the Street has EPS going from $3.50 to $4.73. I’ve got it topping out at $4.25. That’s not horrible. But for one of the best and most stable 20-year charts – with the multiple fully rewarded for it, I think we get significant multiple compression if I’m right. 11x EBITDA and 19x EPS is simply not sustainable. On my model, we’re prob looking at something like $3.60 next year vs the Street at $3.90 – which is probably closer to a 15x pe – or a stock in the mid-$50s.
