For much of the past decade, shares of off-price retailers like TJX Companies (TJX -2.93%) and Ross Stores (ROST -3.65%) moved steadily higher, as it became clear that they were uniquely equipped to avoid disruption from the rise of e-commerce.
However, in the past three years, investors have become more discerning about investing in off-price retail. TJX stock's momentum has petered out during this period, due to a combination of choppy sales results and slower earnings growth. Meanwhile, Ross Stores shares have continued making huge gains.
TJX stock could make a big comeback in 2018, though. The company's rocky 2017 performance gives it a huge opportunity to increase sales and pre-tax earnings next year. Furthermore, tax reform will give TJX an extra earnings boost going forward.
Strong earnings despite a blip in sales
During the current fiscal year, TJX has suffered from a slowdown in comp sales growth. In the first quarter, comp sales increased by just 1%. While comp sales growth rebounded to 3% in Q2, TJX's third-quarter performance was disappointing, with comp sales roughly flat year over year.
Notwithstanding the slowdown in sales growth this year, earnings per share has continued growing at a steady rate. During fiscal 2017, adjusted EPS increased 6% -- from $3.33 to $3.53 -- even though TJX posted stellar comp sales growth of 5% for the full year. Through the first three quarters of fiscal 2018, adjusted EPS increased by 6% again. Surprisingly, the strongest adjusted EPS growth came last quarter, when TJX posted its weakest sales results.
TJX expects its EPS growth to accelerate further in the fourth quarter. Last month, it projected that EPS will rise 11%-13% this quarter, assuming a modest 1%-2% comp sales increase. Given that retail sales trends have bounced back in a big way since the beginning of November, these sales and earnings growth forecasts could prove conservative.
Tax reform will deliver a huge windfall
On average, analysts expect TJX's EPS to reach $4.20 next year, up from $3.93 in the current fiscal year. However, these estimates don't include the benefit of the recently passed tax reform bill, which will reduce the statutory federal corporate tax rate from 35% to 21%.
TJX has more than 1,000 international stores, so it won't get quite as big a boost from tax reform as Ross Stores, which only operates in the U.S. Still, TJX routinely generates more than 80% of its segment profit in the domestic market. Assuming the company's effective tax rate declines to roughly 25%-26% from 38% in recent years, it would increase after-tax profit by about 20%.
This means that if TJX meets analysts' pre-tax profit expectations next year, its EPS would likely surpass $5, including the impact of tax reform. Given that TJX stock has frequently traded for at least 20 times earnings in recent years, the $100 mark should be easily within reach for TJX during 2018.
There's even more EPS growth potential
The outlook for TJX stock could be even brighter if the company can quickly fix its recent execution mistakes. Unseasonable weather patterns contributed to TJX's comp sales slowdown this year, but management also admitted to making some buying mistakes last quarter.
Fortunately, TJX's focus on making buying decisions as late as possible makes it easy for the company to adjust when it makes a mistake. There shouldn't be any lingering impact on sales in the coming year. As a result, facing its easiest year-over-year comparisons in at least three years, TJX will be well positioned to return to mid-single-digit comp sales growth next year.
TJX stock currently trades at a valuation discount of about 20% relative to Ross Stores shares. This reflects Ross Stores' superior revenue and earnings growth lately. However, if TJX can get itself back on track in the next few quarters, that valuation gap should decrease considerably, sending TJX stock to $100 or more.