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3 Observations From TJX Companies' Management Team

By Asit Sharma - Nov 27, 2018 at 1:21PM

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Rising costs, strong comparable sales, and forward earnings ambiguity are currently top of both executives' -- and investors' -- minds.

Shares of TJX Companies (TJX 5.13%) have slipped roughly 6.5% since the organization reported fiscal third-quarter 2019 earnings on Nov. 20. The dip slightly blemishes the stock's year-to-date appreciation of 20%, an admirable ascent since the broader market, as defined by the S&P 500 index, is flat for the year and potentially heading for a negative 12-month performance. Below, let's cull three comments from the management's third-quarter earnings conference call that put near-term negative investor sentiment into context while illuminating factors that may push the "TJX" symbol higher over a longer time horizon.

Rising costs impacted profitability over the last three months

TJX reported diluted third-quarter earnings per share (EPS) of $0.61. After adjusting for the effects of a 2-for-1 stock split during the quarter, EPS exceeded the top of management's forecasted range by $0.02. 

Investors may have expected more robust earnings, given a comparable sales increase of 7% year over year. Within this number, Marmaxx, the company's largest segment (encompassing its T.J. Maxx and Marshalls chains in the U.S.), posted near double-digit "comps" expansion of 9%, against management's previous guidance of 3% to 4% comps growth.

Gross margin figured as one component offsetting higher comps, declining by nearly one percentage point to 28.9% against the third quarter of fiscal 2018. CFO Scott Goldenberg pointed to two culprits across TJX's business segments: rising fuel costs and expenses related to the company's supply chain. Freight costs contributed roughly 50% of the gross margin dip over the last three months. For context, Goldenberg stated: "Importantly, while merchandise margins [i.e. gross margin] decreased in the quarter, it would have been up without the increased pressure from freight." We'll return to the theme of cost creep within cost of sales --as well as within overhead expense -- below.

Wooden hangers on a retail fashion shopping rack.

Image source: Getty Images.

Bottom-line pressures create a hazy fiscal 2020 outlook

I want to take a moment to discuss anticipated headwinds to our EPS growth in fiscal '20 based on what we're seeing today. As we've discussed previously, we're expecting incremental margin pressure to continue from freight, wage increases, and our supply chain investments to support our growth. We expect freight and wage each to have about a 2% negative impact to EPS growth in fiscal '20. --  Goldenberg

Perhaps discomfort regarding earnings in the upcoming 2020 fiscal year (which begins in February 2019) contributed to recent profit-taking in TJX shares. Freight costs, for example, may continue to inflate as they're driven by external forces including continued tight capacity in the U.S. trucking market.

Wage expense will rise as both a function of cost-of-living adjustments TJX plans to institute and external pressure as many states continue to raise minimum wage standards. A higher wage expense will manifest in overhead line items (i.e. selling, general, and administrative expenses), thus dragging on operating margin.

TJX hasn't issued a fiscal 2020 forecast yet. During the earnings call, CEO Ernie Herrman mentioned that while the company is still finalizing its 2020 forecast, management's projection for full-year diluted EPS is more likely to "tick down" rather than up versus full-year fiscal 2019 earnings. Adding to wage and fuel costs, Herrman cited foreign currency fluctuation, the impacts of Brexit in the U.K., and tariffs as three major factors clouding the earnings per share outlook.

In particular, Herrman focused on tariffs as having a potentially significant impact on earnings, pointing to uncertainty surrounding the effects of import tariffs on TJX's vendors, as well as ambiguity over competitors' plans to adjust pricing to compensate for higher merchandise costs. 

Resilience in TJX's business model

I'd like to reiterate the key reasons for our confidence in our continued successful growth around the world. First, our focus on value has served us extremely well through all kinds of retail and economic environments over our 40+ year history, and this gives us great confidence in our future. We have delivered positive annual comp sales for 22 consecutive years. And in an evolving retail landscape where many retailers are seeking different ways to attract customer traffic, we are proud that our core off-price concept continues to drive our traffic and sales increases. -- Herrman

Herrman's comment above seeks to explain why TJX companies can prosper even in a cost environment that promises to be more volatile in the upcoming fiscal year. Improving traffic is a persuasive reason: Management cited higher traffic as the primary driver of the company's third-quarter comps performance in Marmaxx as well as its HomeGoods home furnishings segment. Executives appear confident that improving sales levels will continue to absorb a portion of climbing expenses.

Herrman enumerated several additional reasons that the company's business model would amplify earnings in the coming years despite a potential EPS slowdown in 2020. These include the organization's nimble purchasing capabilities, a "flexible supply chain and store format," which allows TJX to respond quickly to trending fashion and furnishing items, and the opportunity to eventually expand to over 6,100 locations (from a current total of roughly 4,200) even if it simply remains within its current geographical markets.

Most importantly, Herrman indicated, the company sees ample long-term global availability of inventory to support its model. To read between the lines, this implies that within the peaks and troughs of economic cycles, clothing manufacturers, distributors, and full-price retailers will continue to need a deep-pocketed buyer in the marketplace onto which they can unload unsold product.

To this point, the world's largest off-price fashion retailer currently boasts $3.3 billion in working capital, $1 billion in unused credit lines, and sports a debt-to-EBITDA ratio of roughly 0.5 times. This debt ratio implies an extremely low level of leverage, meaning that the company has access to billions more in long-term financing if needed. In sum, TJX Companies won't lack for firepower over the long term to obtain its most important asset -- discounted merchandise.

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