TJX Companies: Get In For The Long Haul
Summary
TJX posted an excellent Q4 buoyed by a major increase in returns of capital to shareholders.
The company continues to source inventory from diverse places, including e-commerce.
Im increasing my fair value to $92, but I can see further upside if TJX's guidance proves to be conservative.
TJX Companies (TJX) reported another fantastic quarter late last week with revenue and earnings surging higher. With the company feeling the benefits of tax reform leading to higher free cash flow, a stronger dividend and even more share repurchases, I am increasing my fair value to $92 per share. I believe the company looks like an excellent opportunity, even after its recent increase. Let's take a look at quarterly financials, why e-commerce is good for TJX and the new increases in shareholder returns.
Q4 - A Strong Comp Recovery
Skeptics were starting to say that the long reign that TJX had growing comps was coming to an end. Q3 comps were basically flat, including a decline of 1% at the flagship Marmaxx and up just 3% at Homegoods. TJX recovered nicely, as overall comps were up 4% y/y on top of a 3% increase in Q4 of 2017. Strength was broad-based, with Marmaxx, Homegoods and International all up 3% y/y, while Canada grew a robust 7% y/y.
All told, FY18 sales were up 8%y/y to $35.9 billion, which drove adjusted EPS of $3.85 per share, an increase of 9% y/y.
TJX experienced a number of one-time expenses, including paying out bonuses to associates, funding charitable contributions, extra retirement contributions and impairment to Sierra Trading Post. If we exclude all of these one-time events as well as the extra selling week, which makes sense given the one-time tax windfall and the odd calendar occurrence, operating margin was about 0.1% lower y/y at 11.5% of sales.
Adjusted SG&A was actually down 0.3 percentage points due to comp leverage, so the margin decline actually came from a rare decline in gross margin, which fell 0.4 percentage points y/y to 27.9% of sales. Management attributed this decline to some issues with freight at Homegoods that created late holiday arrivals and subsequently resulted in deeper discounting to move holiday inventory. This is uncharacteristic of TJX and I would not read much into it. Freight will be a source of some margin deleverage going forward, but a few basis points up or down is immaterial to the long-term valuation.
Inventory was in good shape, up about 4% y/y in constant currencies. This is consistent with the 4% comp TJX experienced in Q4 and it portends a pretty healthy inventory position heading into FY19.
One great aspect of the TJX business model is the ability to flex inventory up or down based on selective buys. Though inventory was up 4% this year, inventory was down 4% y/y during the comparable period of FY17.
Even with huge net working capital drags from an increase in inventory and a large increase in receivables, TJX generated just shy of $2 billion in free cash flow during FY18. This was achieved even after opening 258 net new stores and increasing gross square footage by 4.4%. TJX continues to add stores in virtually every geographic area, worldwide, providing it with a steady place to reinvest capital at high rates of return.
E-commerce can be good for TJX
One of the great and underrated aspects of the TJX model is its ability to thrive in spite of e-commerce. Every analyst harps home the notion of the "treasure hunt" which makes TJX and Ross Stores (ROST) unique shopping experiences that warrant frequent visits.
However, one really interesting facet of the model, in my view, is that TJX actually can benefit from e-commerce in the same way it benefits from department stores ordering too much inventory. Like department stores, retailers are not able to perfectly plan inventory because the future and changes in fashion are unpredictable. Additionally, and this is something Foot Locker (FL) actually noted on its earnings call, brands do not want to satisfy the last marginal unit of demand. In some cases, it is better to leave money on the table to avoid discounting.
In this instance, TJX is there to pick up excess inventory and blow it out without anyone becoming aware. I imagine that virtually any retailer would prefer to move inventory through the TJX channel as it avoids the same advertising and price transparency typically associated with discounting. Equally as important, TJX can disperse the inventory across its massive store network, with the small allocations barely hinting that a single brand had an inventory problem.
Less positively, TJX marked down Sierra Trading Post by $100 million. This is pretty poor, especially considering the 2012 purchase price of $200 million. The impairment suggests TJX overpaid by at least 50% and I think we could see further reductions going forward.
Frankly, I have never considered Sierra Trading Post a material part of the business to evaluate and I still do not. However, the acquisition underscores that sometimes it's better to keep reinvesting in your business or give the cash to your shareholders rather than to buy companies outside of your core competency.
Shareholder Returns: Getting Better All the Time
TJX announced a massive 25% increase in its dividend to $0.39 per share. This equates to a dividend yield of nearly 1.9% at current prices. I do not love dividends, but I suppose I will accept a dividend hike rather than another Sierra Trading Post.
More attractive, in my view, is the substantial increase in buyback authorization by $3 billion in FY19. The company expects to repurchase $2.5-3.0 billion worth of stock during the fiscal year, which could ultimately reduce the share count by another 5%. This is exactly the tax efficient return of capital that I desire. TJX already bought back $1.7 billion worth of stock for an average price of roughly $76.25 in FY18. Clearly, this investment is already accretive.
With the lower tax rate and a lower share count, I am increasing my DCF valuation to $92 per share. This implies upside of almost 10% from current levels, without accounting for the dividend. This price could prove conservative if TJX is able to perform better than expected on the operating margin line in FY19. Core EPS is only expected to grow 4-6% (excludes the impact of the tax cuts) thanks to a 2% labor cost headwind and an anticipated comp growth of just 1-2%. I think these numbers could be conservative and TJX could see upside to the mid-$90 range.
TJX Companies: Get In For The Long Haul - TJX Companies Inc. (NYSE:TJX) | Seeking Alpha
