INVESTMENT THESIS
We are maintaining our BUY recommendation on TJX Companies Inc. (NYSE: TJX) and raising our target price to $78 from $75. TJX, which has grown during past recessions, and thrived as Amazon has taken share from traditional retailers, is facing an unforeseen setback because COVID-19 forced it to close its stores. Remote learning mandates weighed on back-to-school shopping across the industry and core shoppers were cautious about leaving home even as stores reopened. Repositioning stores for social distancing considerations and initial supply chain disruptions had inventories below optimal levels at the end of 2Q. In the third quarter, the company saw better inventory availability and an excellent environment to add new vendors and acquire merchandise.
This should lead to an improving inventory flow in the important fourth quarter.
While there is significant economic uncertainty, TJX is one of our favorite retailers in a scenario where concerns about COVID ease and the economic recovery remains on track.
TJX is normally a strong and viable business, and it was able to draw $1 billion on its revolving credit facilities and borrow $4 billion in the bond market to help it through the early stages of the crisis. Liquidity is improving and the company is working to restore its balance sheet. In the second quarter, the company repaid the borrowings on the revolver and at the beginning of 3Q the company increased its access to cash by increasing the borrowing capacity under its revolver by $500 million to $1.5 billion. On the 3Q conference call, TJX announced, then subsequently executed, a plan to repurchase and refinance the high coupon bonds it issued earlier in the year.
The company’s edge is that its merchants offer a treasure hunt of unique, brand-name merchandise at bargain prices. The company’s skilled merchants, lean cost structure and ability to satisfy bargain hunters should lead it through this epidemic, the recovery, and a return to ‘normal’ times. The company’s current business model is dependent on in-store traffic. While it may take several months to inoculate a significant portion of the population, the presence of an approved vaccine provides a small boost to our 2H22 outlook for TJX.
We expect TJX to recover and benefit as it acquires great merchandise from overstocked retailers and vendors. We remain very bullish on the company’s long-term prospects and are reiterating our five-year BUY rating, but with the stores having been closed and the dividend having been on hold, the shares are a riskier proposition than Walmart, for example, whose offering of groceries and medicine allowed it to remain open and sell clothing and general merchandise as well. Earlier this year we reduced our financial strength assessment by onenotch to Medium, from Medium-High. The recent increases in our price target reflect a partial reduction of the risk premium in our dividend discount model as liquidity improves and management makes progress in restoring financial strength and reinstating the dividend.
RECENT DEVELOPMENTS
On December 8, TJX formally declared a $0.26 per share dividend that will be payable on March 4, 2021. In the 3Q call, management trumpeted the potential reinstatement as a sign of its confidence in the company’s liquidity and financial flexibility.
The last dividend the company paid was $0.23 on March 5, 2020. The new $0.26 dividend represents a 13% increase from the pre-pandemic payout of $0.23 As a reminder, on March 19, 2020, TJX announced that it was temporarily closing stores drawing $1 billion from its credit facilities, suspending its robust share repurchase plan, reviewing its dividend plan, reviewing all operating expenses and reducing capital expenditures.
EARNINGS & GROWTH ANALYSIS
We are maintaining our 4Q EPS estimate of $0.63 and our FY21 estimate of $0.44. We are raising our FY22 EPS estimate to $2.75 from $2.70. The stores should be reloaded with great merchandise from overstocked stores and vendors. While we realize that getting a significant portion of the U.S population vaccinated will take time, we are slightly more optimistic about second-half prospects than we were a few weeks ago. We remain very upbeat about the company’s ability to gain market share as record numbers of retailers shut their doors.
Our five-year average annual EPS growth rate forecast remains 12%. While we have not yet made a formal estimate for FY23, we are expecting double-digit EPS growth to be slightly more than $3.00 per share, which is slightly higher than we previously expected.
FINANCIAL STRENGTH & DIVIDEND
We recently reduced our financial strength rating for TJX to Medium from Medium-High. The company still has a great business model, but COVID-19 forced it to close stores and to borrow $1 billion on its revolving credit facility and $4 billion in the bond market to help it through. We are very optimistic about the company’s prospects, but right now their financial strength is not at the same level as Walmart, Costco, Home Depot and Colgate.
TJX did not declare a 1Q21, 2Q21or 3Q21 dividend. The company did declare a $0.26 per share dividend in 4Q21 (December 8, 2020) but for our purposes the dividend will be paid in March 2021 and included in our FY22 estimate. The company has suspended the share repurchase plan and said in the 10-Q for 3Q21 that it did not expect to pay a dividend in 4Q21. While it is possible that the company will reinstate the repurchase plan when they announce 4Q earnings in late February of 2021, we are in no rush to see buyback activity until comparable sales and profitability improve and the company’s single-A ratings no longer have negative outlooks from Moody’s and S&P.
In 2Q, TJX repaid the $1 billion it borrowed on its revolving credit facility.
The company’s operating margins have declined slightly over the last several years, but the FY19 margin of 10.7% and the FY20 margin of 10.6% are strong for the retailers we follow. This is an indication that the business is profitable and well managed. Profitability will plunge in FY21, but it should rebound to a healthy level in FY22. We are modeling a 2.4% operating margin in FY21 with a rebound to more than 10% in FY22. TJX maintains a relatively lean cost structure and management is well aware of the need to tightly control inventories. Good inventory management reduces the need for markdowns and keeps new merchandise flowing to the shelves. Fresh merchandise also gives shoppers a reason to visit regularly.
Total debt was 74% of capital at the end of 3Q21, which is lower than 77% at the end of 2Q21, but up from 66% at the end of 4Q20. EBIT covered net interest expense by 80-times or more in FY16, FY17, FY18, FY19 and FY20. EBIT covered interest expense (not offset by interest income) by over 60-times in FY20. That will surely decline in FY21 as EBIT declines significantly and interest expense increases. We are modeling coverage of 4-times in FY21 and a significant rebound to more than 25-times in FY22.
The company’s debt is rated in the single-A range, which is very solidly investment grade, but both Moody’s and S&P have negative outlooks. The company has top-tier A-1/P-1 short-term ratings, but those could drop to A-2/P-2 if the long-term ratings fall into the BBBs. This will be a question of how fast business rebounds and how much forbearance the rating agencies allow.
We estimate that the company’s debt (adjusted for leases) was about 2.5-times EBIT plus depreciation and rental expense at the end of fiscal 2011, 2.4-times at the end of FY12, 2.3-times in FY13, and 2.2-times at the end of both FY14 and FY15. We believe this is consistent with the company’s single-A credit ratings. The ratio was approximately 2.4-times at the end of FY16, 2.5-times at the end of FY17, 1.9-times at the end of FY18, 2.4-times at the end of FY19 and less than two-times in FY19.
In FY19, dividends totaled $0.74 per share. The company raised the dividend by 18% beginning with the June 2019 payment. FY20 dividends totaled $0.89. Our FY21 dividend estimate had been $1.00 per share prior to the COVID-19 crisis. Our dividend calculation is based on dividends paid, not declared during a fiscal year. The company made one dividend payment of $0.23 per share in FY21. This counts in our FY21 dividend estimate even though it was declared in FY20. The company did not declare a dividend in 1Q21, 2Q21 or 3Q21. As expected, it declared a $0.26 dividend on December 8 that will be paid in on March 4, 2021 (1Q22). Our current dividend forecast is $0.23 in FY21. We are raising our FY22 dividend estimate to $1.14 from $1.04. This is about a 10% increase.
The company has an impressive history of repurchasing stock, with more than $22 billion in repurchases since 1997. In February 2017, the company authorized a new $1 billion buyback on top of the $1.4 billion remaining under its existing authorization. The company repurchased $1.7 billion of its stock in FY17 and it bought back another $1.7 billion in FY18. TJX repurchased $2.5 billion of its stock in FY19. TJX repurchased approximately $1.6 billion of stock in FY20. The company ended FY20 with $1.7 billion of capacity under the buyback plan and authorized $1.5 billion in February. TJX repurchased about $200 million of shares in the early part of FY21, leaving it with capacity of $3 billion. The company suspended the buyback plan in the wake of the COVID-19 crisis. We don’t think the company should repurchase shares until the credit ratings are stable at single-A levels.
MANAGEMENT & RISKS
The biggest risk facing the company is that its stores were closed because of the coronavirus epidemic. That eliminated the company’s cash flow and made it more difficult to pay rent, wages, benefits and vendors. The company ended 3Q with improved liquidity, but financial flexibility is likely to be constrained for several quarters. It may also take some time for the company to get back into its normal flow of merchandise to drive store traffic. In addition, some core shoppers may be reluctant to enter stores and may prefer to make online purchases.
Ernie Herrman became CEO in January 2016, replacing Carol Meyrowitz, who has become the executive chairman. Mr. Herrman previously served as the company’s president. He has experience as the head of Marmaxx and as the top merchant at Marmaxx, with a tenure at the company that goes back to 1989.
We believe that the expertise Ms. Meyrowitz gained as a merchant was a tremendous benefit to the company. We also believe that a key to the company’s future success will be using the merchandising savvy of over 1,100 buyers, and their relationships with over 21,000 vendors, to get high-quality, off-priced merchandise from popular brands and designers. A constant flow of this merchandise will help to create the ‘treasure hunt’ atmosphere that can drive store traffic and augment same-store sales. We believe that executing this strategy depends on the discretion and fortitude of the company’s merchants, and that could be a risk factor if they aren’t successful.
The availability of off-priced merchandise is another issue that we believe to be on the minds of many investors. We spoke to the company’s investor relations department about this and were told that investors have continually asked about this issue as sales have climbed. The company has said that there is abundant merchandise available from manufacturer overruns, closeouts, retailer order cancelations, and special production. Based on our prepandemic store visits we see no reason to doubt that. While we don’t think that the opportunity to buy such merchandise will disappear in the long run, we do wonder whether the increasing emphasis on inventory management by manufacturers and retailers, along with the presence direct competitors like Ross, of company-owned outlets – such as Nordstrom’s growing Rack chain, Saks’ Off 5th, Macy’s Backstage and Williams-Sonoma’s outlet stores – may be a risk factor. Bloomingdale’s and Macy’s are even getting into the act. One thing to note is that some outlets sell merchandise that is designed specifically to be sold at outlet stores. We believe that this is less desirable to shoppers than the top-tier brands that TJX typically sells. We shop TJX regularly and find Under Armour workout shirts for less than $15, shorts for less than $20 and sweats for less than $30.
We once asked management which companies it views as its primary competition and were told that the company’s main focus is trying to get its own execution right. In our opinion, that is a good answer and probably a good approach. We do think the company has a lot of indirect competition. In addition to the outlets mentioned above, Polo, The Gap, Tommy Hilfiger, Ann Taylor, Eddie Bauer, Armani Exchange and Guess all have outlet stores. We lso believe that other stores, such as Target, Kohl’s, J.C. Penney and Wal-Mart, are all striving to offer high-quality and fashionable merchandise in convenient settings and at attractive prices.
HomeGoods faces competition from some outlets and department stores, as well as from retailers like Bed Bath & Beyond, Pottery Barn, and West Elm. HomeGoods does differentiate itself from its competition with an eclectic and ever-changing mix of unique items. We also believe that customers go to HomeGoods for individual pieces and accessories which further differentiates them from brick-and-mortar competitors where shoppers are looking for ensembles.
Another component of the company’s overall strategy is international growth. In many ways, this can be a risk-reduction strategy (especially in businesses like retail, where weather and declines in consumer confidence can hurt sales), as well as a means of reaching less saturated markets. Political risk has not been a major concern for us, because these international stores are mainly in Canada and the U.K. with a smattering in Western Europe and Australia. Familia is privately owned. Exchange rates and slow international growth can sometimes surprise investors who don’t pay enough attention to international events. A stronger dollar could be a drag on earnings and lead to disappointments after a period where it helped profits.
TJX is involved in several legal proceedings and regulatory matters, including a class-action suit related to the ‘Compare at’ pricing that appears on the company’s price tags, as reported in its most recent annual report. The outcome of these issues is difficult to predict. The company does not have significant financial statement accruals against future suits. P ricewaterhouseCoopers has been the company’s auditor since 1962.
COMPANY DESCRIPTION
TJX Companies Inc. sells name-brand merchandise at discounted prices. The company operates 4,529 stores, in the U.S., 513 stores in Canada, and 726 stores in Europe and Australia. In FY20, the company posted sales of $42 billion, with 76% in the U.S., 10% in Canada, and 13% in Europe and 1% in Australia. Clothing and footwear is the major product category, at 51% of sales. Jewelry and accessories represent 16% and home products represent 33%. The company, based in Framingham, Massachusetts, has approximately 250,000 associates worldwide and more than 21,000 vendors sourcing products from over 100 countries.
The fiscal year that ended on February 3, 2018 had 53 weeks. The current FY21willend on January 30, 2021.
VALUATION
TJX shares are up 10% over the last year and up 9% this year.U sing a dividend discount model with our increased estimates for FY22 earnings and dividends as well as a slightly higher preliminary outlook for FY23, we arrive at a value of approximately $78 per share. We expect the company to recover, and return to profitability and double-digit earnings growth.
With regard to this model, we note that the company has historically earned high returns on shareholders’ equity and should be able to maintain a very healthy payout ratio in its steady-growth phase because it maintains a lean cost structure, uses its retail space efficiently, and quickly adapts to changes in product preferences. We are still using a cost of equity of 8% during the five-year growth phase in our model, and a cost of equity of 7.5% in the stable growth phase on the expectation that the company’s historical financial strength and earnings consistency will return.
We are raising our 12-month price target to $78 from $75 reflecting our considerable optimism in the company’s long-term prospects.
On December 16 at midday, BUY-rated TJX traded at $66.70, down $0.04. Report created Dec 16, 2020.
Source: Argus
