In this episode of Industry Focus: Wildcard, Dylan Lewis chats with Motley Fool contributor Asit Sharma about some of the biggest consumer goods companies' earnings and how they've been performing lately. Discover how these retailers are experimenting with different footprint styles, optimizing inventory, managing debt, rewarding shareholders, and much more. Listen in to hear about Costco's dividend.

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This video was recorded on November 18, 2020.

Dylan Lewis: It's Wednesday, November 18th, and we are talking about retail news and earnings. I'm your host Dylan Lewis, and I'm joined by Fool.com's Asit Sharma. Asit, it has been far too long since we've gotten together, but since I'm talking consumer goods, I have to have you on this Wildcard Wednesday episode.

Asit Sharma: Well, thanks, Dylan. I'm really excited to be here, and I'm pumped about the tickers that we're going to discuss today, because I like them all, they're very interesting.

Lewis: You know, one of them is kind of a sore spot for me, because I was a shareholder of the first company, we're going to be talking about Costco (NASDAQ:COST) for a while, and at a certain point was kind of moving a little bit more tech with my portfolio and wound up unfortunately selling it so that I could buy some other things. As we'll get to, when we start putting some numbers to the company's returns over the last couple of years, that's been a mistake on my part. [laughs]

Sharma: Well, I want to say, I don't know how much of a mistake it is. You know, Warren Buffett sold out of his shares, we found out in his latest filing, but even uncle Warren can be wrong [laughs] once in a while. I still like Costco, I'm a shareholder.

Lewis: [laughs] Oh, yeah. And I love it as a consumer; I think that was one of my mistakes, it was just keying a little bit too much on, you know, feeling like I needed to be making moves and feeling like the zero-sum element of investing was, kind of, getting at me. And you know, it's something where you feel like you only have so much cash and you have a lot of ideas, and sometimes that can force you to make some bad decisions. In my case, because of that, I sold a couple of years ago, I am missing out on what will be a special dividend and what Costco has recently announced shareholders will be receiving in December.

Sharma: Yeah, Costco is going to pay out a special cash dividend of $10/share on December 11th. And you know, Dylan, we were chatting about this beforehand, some listeners might not be familiar with what a special dividend is, so I wanted to explain it in just a few words and then, I don't know, if we can toss that around or move on to some more specifics about this dividend. But a special dividend is irregular, it's discretionary; just as you might think from hearing the name, it's not a regular dividend. A company's Board of Directors and/or Management Team will decide in a special situation to disburse a cash dividend to people who hold the stock. And I think this is going to be a great way to reward shareholders.

If you happen to have excess cash on your books, which Costco does, sometimes you can have excess cash on your balance sheet because you've got a windfall, maybe from the sale of, like, a business division. But in this case, it's because Costco has really amazing, stable operating cash flows that just start piling up [laughs] in its checking account.

Lewis: Yeah, I guess that the beauty of the Costco model here is, you know, we've talked about it so many times on the show and in various Fool formats, but the comp numbers for them, the store sales numbers for them matter, but they only matter so much. Because with this business, being a membership business, most of the margin, most of the cash flow is going to be coming from their members.

Sharma: Yeah. And it's amazing, I mean, if you look at the company's profit margins over time, they tend to be half-a-percentage point on either side of 2%. [laughs] So, at the end of the year Costco has taken home $2-and-change on every $100 that it sells. And that $2, Dylan, that hits that bottom-line is mostly due to those membership that manages the rest of the business, sort of, at breakeven, but when you're selling, I don't know, $116 billion worth of merchandise in a year, [laughs] that small profit margin adds up to some big dollars.

Lewis: Yeah, and it lets them pass those cost savings along to customers with their famous bulk approach. I think it also is something where maybe Costco is little uniquely positioned for COVID, because by nature it's a store that people don't go to all that often. And you know, people probably don't feel the pinch of not being able to necessarily go to a Costco every week the way they might a traditional supermarket, so I don't know that they saw a major dip in their members during this period, because people are, kind of, used to only going once every month or two months.

Sharma: Yeah, I think they've been pretty solid on that front, and if anything, COVID has just reinforced the value of it to members. A couple of stats that I wanted to throw out on this [laughs] special dividend, Dylan. How much is it going to cost to send every shareholder a $10 dividend? It's going to cost them $4.4 billion, but it happens to have about $3.25 billion on its balance sheet in excess working capital. That's just current assets minus liabilities that are due within one year. So, when you think about it, heading into the holiday season and the kind of cash flow it typically generates, it's going to come out on the other side of this without really having a working capital deficit. It'll still have [laughs] positive working capital the next time it reports, which I think is just, sort of, the magic of the way this company operates.

And bully for them for sharing the spoils. This is like the fourth special dividend that Costco has paid out in the last eight years. I just jotted down some notes, just I'll read these out. We'll start with December of 2012, it paid out $7 to shareholders. Followed that a couple of years later in February of 2015 with a $5 special dividend. And in May of 2017 it hit shareholders up for or shareholders [laughs] received another $7 in special dividend. So, for a special dividend, it's been doling these out on a pretty regular basis.

Lewis: Yeah, I think hitting shareholders up for a $7 dividend [laughs] would be something that would cause some flight from the company. But I think what's kind of funny is, you know, we think of special dividends as being something that you really can't bank on. You know, this is kind of a one-time thing. And yes, Costco has a dividend program, but you know, getting $10/share is, kind of, far in excess of what you should be used to.

[laughs] There is a little bit of a bankability to Costco's special dividend, in that you know, every couple of years management is probably going to be kicking the idea around.

Sharma: Yeah, and it's sort of easy to ignore this, I mean it's easy to ignore Costco, in general. Like you Dylan, I have made the mistake several times of selling some great stocks, moving into other promising opportunities, but we all hit that once in a while.

You know, since December of 2012, when Costco paid out its first special dividend, the stock price has done really, really well just on its own, it's increased 269% cumulatively. But if you account for those special dividends and regular dividends, which the yield isn't very much on Costco's dividend, I think it's like three quarters of one%. The total return on Costco's shares, over that same period, is 362%. So, you have almost 100% more performance. And that looks like a tech stock, [laughs] if you think about it, from December 2012 'till now, a 362% cumulative total return; that's pretty impressive.

Lewis: It is. And I think that spread between total return and what you wind up getting, you know, if you're just looking at the price basis, it's maybe a little bit bigger than you'd expect because of that special dividend policy that they've been able to go to every now-and-then, but I think just the pure return number is a good reminder that Costco is a little bit of one of those best of both worlds stocks, where there is the share price appreciation. You know, they have a really strong business that is continuing to put up good results, they have a very low churn membership model. And they have that just under 1% yield as well. I know sometimes the dividend investors out there might look at something and say, less than 1%, you know, why am I buying this as a dividend stock? And then you look at the total return and you say, wow! This is pretty darn impressive. It feels a little bit like the Microsofts and Apples of the world, where they're not going to be blowing the doors off with the yield that they're giving investors, but when you take the whole picture into account, it winds up being pretty impressive.

Sharma: Yeah, these are, like, double-take stocks, Costco, Apple, Microsoft. I think it's a really astute point, Dylan, they just cause you to look again, because from year-to-year they're not grabbing headlines, especially Costco, [laughs] maybe Apple and Microsoft are bigger and more forward in investors' minds than Costco, but it's interesting just how through its distribution model, its slow expansion in its store base, it keeps turning out bigger and bigger profits.

One thing about Costco that I really like, which sort of supports what you're talking about, is that they always look ahead toward the next great thing, knowing that they can't open all these really huge club warehouses at a superfast rate, they like to expand internationally. And they've been focusing on big ticket items, they have spent a lot of money, just this year, on logistics to deliver more appliances to their members, and those will bring a higher total gross profit to the company, which again, just turns into a lot of cash flow after you cover those fixed costs. So, I agree with you, it's definitely the best of both worlds stock.

And my gripe is I haven't bought more of it, you know, [laughs] it's a tiny position in my portfolio, I have to make myself buy some more soon.

Lewis: For the income investors out there that are still not convinced, I want to throw one more thing out there, and because the yield is low, you might not notice it, but they have been quietly paying and increasing their dividend every year since 2004. And because it's less than 1%, it's probably not going to pop-up on a lot of stock screeners, if you're looking by yield, and you're going to wind up missing it. But I'm going to guess, Asit, that if you fast forward to 2029, we might be looking at a company that has a yield below 1% but is a dividend aristocrat.

Sharma: I would not bet against that, Dylan. I think you're probably 99% [laughs] there, correct. I mean, there's always a chance that something happens to disrupt the business model, but man! over the past several years, they just seem to be fortifying that big competitive moat. They've got some regional competitors, BJ's is a really healthy competitor up in the Northeast, and they do compete with Sam's Club from Walmart (NYSE:WMT). So, maybe something could stall that growth, but the model is just so set, and they do so well in execution that I have to agree with you [laughs] it's going to be a dividend aristocrat. So, we'll have to rewind the tape, what, nine years from now, [laughs] to see if you're right.

Lewis: [laughs] That's the downside of doing this, right, is we're always immediately accountable, and we think that's so important here at The Fool, but it does mean we're definitely accountable. And, Asit, for the folks that are convinced here and are looking at this pretty seriously as a potential income investment or just something that they want to own regardless of whether they're an income investor or a growth investor, what are the details on the special dividend?

Sharma: So, if you want to get in on this, they basically are going to pay this dividend out on December 11th, but it doesn't mean that if you buy the stock on the 11, you'll get that nice dividend, you need to be a shareholder of record at the close of business on December 2nd, that means that you're in Costco's books as a shareholder on that date, but that doesn't mean that if you buy the stock [laughs] on the 2nd of December you'll get the dividend. Because of the way trade settlements work, the famous T+ 2, so trade date plus two days, you have to be a shareholder two days before the 2nd of December to actually participate in this dividend.

The other thing that we should remind investors is, when you're looking at Costco's stock price on the 11th, if you are a shareholder, you're going to see the stock price get adjusted by $10. Why is that? I mean, it sort of makes sense, and when I was a younger investor, I could never quite understand it, but it works like this: people who don't own the stock and aren't going to participate in that dividend need a discount to buy the stock. So, stocks actually regularly are adjusted, even for quarterly dividends, if you pay attention, even for a small quarterly dividend, you'll see a company's stock price get adjusted by that dividend amount every time it issues a dividend. So, don't get too worried if you see that stock price decline, because if you think about it, you just got the difference in cash. [laughs]

Lewis: Yeah, I think it's a good reminder, and because it's a $10 dividend, it's really illustrative, that when we're looking at a share price of a business, when we're looking at the overall value of the business, it's an approximation of that business' ability to generate cash in the future and basically create returns for investors. And the dividend is, kind of, one of the most tangible ways that we can see that happen, you know, either on a quarterly basis, or in this case, due to a specific date and time that that money is going to be paid. And so, you kind of have to reweight as those payments come through and make sure that you're not, you know, stiffing people that are buying it after these deadlines and having them artificially pay a higher price.

Sharma: Yeah, for sure. And over time though, it all works out, stocks tend to keep rising, if they've got strong operating cash flows and nice margin. So, it works out in the long-run.

Lewis: Yeah, more of a disclaimer not to panic [laughs] if you're a Costco shareholder and you see that dip. Asit, so the special dividend from Costco came from them being in a position of strength on their balance sheet; that's what I saw from management. And I think based on what I've seen come in from a lot of the retailers, there's maybe some surprising strength in retail right now in a way that maybe some people weren't quite expecting.

Sharma: Yeah, it's taken me by surprise a little bit, because so many retailers were in the worst [laughs] kind of shape in March and April, shutting down stores, trying to figure out how they were going to cope. And from that, we saw a lot of retailers, speaking of balance sheets, borrow a bunch of money to fortify those balance sheets and make sure they could get through what was, in retrospect, still a very difficult year. But we've got a slew of earnings that have come out this week from some of the biggest names in retail, and those definitely are showing that they are now operating from a position of strength.

Lewis: Yeah. And what I love about this is we have the pairings. So, we have Walmart and Target, we have Home Depot, Lowe's, Kohl's, TJX, we can kind of bucket these companies and say, you know, Walmart and Target are easy comps, look at these numbers together. We have Home Depot and Lowe's, the home improvement specialists. And then we have Kohl's and TJX, the two businesses that have, kind of, mastered the idea of discounting. And so, it's fun to be able to stack these numbers next to each other and just kind of get a sense of, within retail, how all of these little niches are operating. Let's start out with Walmart and Target.

Sharma: Sure. So, these are two companies that have both made really significant investments in e-commerce before the pandemic. So, it might be easy to say, in retrospect, oh, we knew something like this was coming, but really, it was more of a business model decision. Both Walmart and Target decided several years ago that they would try to fulfill a lot of e-commerce from their stores instead of building big distribution warehouses and trying to compete with Amazon's model, because that was the big e-commerce threat. And so, that turned out to be just extremely beneficial during this period, because most of us stayed home and we stopped shopping as often in retail environments, but we did order a lot of merchandise. And personally, Dylan, I don't know about you, but I definitely have picked up merchandise from stores that I used to go to in-person. Target is one of them, Kohl's which is another ticker that we're going to talk about, I've done it from Kohl's as well.

So, I really liked both of the results that just came out; Target, in particular. They are crushing it with their e-commerce sales. For the first time I really think that they are aptly named, because they are right on Target, we'll talk a little bit about that. And Walmart is seeing pretty nice growth in its Sam's Clubs Warehouse businesses, because consumers are continuing to stuff pantries. We have, unfortunately, maybe another big sustained wave of COVID cases. So, what is not so great for the country is turning out to be not so bad for this pair.

Lewis: Yeah, I think if you do a cursory look at the news reports around the earnings for these businesses, you are going to see, in the first paragraph, the e-commerce numbers get thrown out there. And what I saw, you know, just quickly looking at Walmart's results was, you know, we saw year-over-year growth, which is great, thanks to nearly 80% e-commerce growth in the United States, which is incredible. And it's a testament to the investments that they've made. I think they probably would've been caught much more flatfooted, same for Target, if those weren't there. Because I know personally, you know, we have a Target nearby, but I'm going and doing a lot of shopping [laughs] at once and then not going again for a long time.

Sharma: Yeah, me the same. And I think you're right, we saw this in some other retailers that have not been as successful during COVID, because they just weren't prepared to shift so quickly to e-commerce. And if you think about these companies in a non-pandemic environment, they're usually increasing comps, compatible sales, by like 2% year-over-year. [laughs] 3% is a good year for a retailer like Walmart if it increases its comparable sales by 3%. So, looking at Walmart, it had U.S. comparable sales up 6.4% this quarter, which I think is a little slowdown from some of the previous quarters, but still that's just really strong business for them. And you're absolutely right, it's that e-commerce piece that is bulking up the rest of the business.

Lewis: I think what's particularly interesting looking at these results, honing in on what we got from Target, comps are up 20%, Asit. And some of that, we see the breakout here, there are a couple of things that go into that comps number. The number of times people are coming to the store, and then the traffic coming into the store, and then basically the average ticket that, you know, what people are paying at the store, a huge chunk of that growth came from the second part.

Sharma: Yeah, it's so interesting because -- well, for maybe that one person on this podcast who hasn't [laughs] shopped at Target, they have such a nice multi-pronged strategy with their merchandise enduring the pandemic, this is why Dylan is making fewer trips, but having a bigger ticket, and me too. Because, yeah, you can pick up some groceries, you can pick up the electronics that you might need for gaming, if you're interested in gaming, you can pick up some office furniture, if you have to prop up your home environment because of Zoom calls, clothing. I mean, you name it, they have been building up these merchandise categories over the years and they were just tailor made for the pandemic.

So, absolutely, traffic growth up 4.5%, but 15.6% growth in average ticket, because we don't want to be going to Target every day, [laughs] I don't want to be going to any retail environment every day. And I used to spend so much time. My kids are aging out of high school now, but I still have one in high school, which is near my wife's work downtown. And so, we used to stop quite a bit in all kinds of stores. And that's all changed. I mean, you're buying more every time you go, and this makes so much sense.

I should say, Target digital comparable sales up 155%, they seem to have had more success than almost any retailer that I can think of, Dylan, on that digital side. And part of that is, because they spent so much time and money on their same-day services, they built their order pickup, their drive-up business, and they have this Shipt delivery business. All those investments just sort of came together, and that really helped. Same-day services also prop-up the sales. I've got here in my notes that that one type of service increased by 217% year-over-year in this last quarter.

Lewis: Yeah, Asit, you mentioned groceries. And I think that that is a key element of some of this where, you know, for the likes of Walmart and Target, we have seen huge investments in the grocery space over the last five years or so. And especially if Walmart is pretty much the only game in town, the addition of a grocery aisle or whole section is pretty great, because [laughs] when you're trying to limit your retail exposure, you're trying to limit the amount of time you're going outside, to be able to go to one place, it really highlights the strength of everything they do. These investments were happening anyways and they happened to really benefit.

I think it's worth reminding our listeners here, as glowing as we're being, particularly about Target, this story has been unfolding for a while. Target had a banner 2019, and they're having a really good 2020. And I think that this is a case of a business just really being in the right place and having the right strategic plan and then having it stress-tested, but really being on the right side of where a lot of industry trends were going.

Sharma: Absolutely. And I have to confess, you know, Target is another company that I've had on my radar screen at different times, Dylan, and just have never pulled the trigger, and now I regret that, but that's what learning [laughs] is about, it's about taking that regret and channeling it into some positive energy. So, next time I see all those signals lighting up at once, I will make a small purchase, I'll get my toe in the water. [laughs]

Lewis: Well, you know, Asit, I like to think that you don't lose, you learn, and that this is a good example of that. And you know, retail, for a variety of reasons, I think has scared a lot of investors away, what we're seeing with some of these companies is there are still really great returns to be earned if you're investing in some of the, kind of, best-of-breed companies in the space.

You mentioned before that folks maybe setting up their home offices and, kind of, laying things out to be able to work from home, was probably a driver for these businesses. I think that stay-at-home has been a surprising driver as well for the likes of Home Depot and Lowe's, where a lot of people, realizing that, hey, this is going to be what we're doing for a while, has decided, you know, we're going to be making these home improvement plans that maybe we've been putting off for a while.

Sharma: For sure. There are so many opportunities for the big do-it-yourself retailers in this pandemic. First of all, people who were thinking of moving into a new home may find themselves, in some markets, priced out or just wanting to delay that purchase because of uncertainty. Second, we've been spending a lot of time outside, so they're seeing some [laughs] great sales in things like gardening, outdoor furniture, and many of us being confined with our families are figuring out that we've got to hit those projects we've been talking about.

And they also offer, Dylan, so many of the home office types of furnishings as well. We might not associate a Home Depot with office furniture, but when you're going through their lighting aisle, you see something that will work perfectly for your Zoom call, etc. So, just so many fronts for them to really grab market share. Now, some would say they're grabbing market share from each other, but I think they also have grabbed market share from some specialty retailers during the pandemic.

Look at Home Depot. So, revenue this last quarter up 23% year-over-year to $6.3 billion, and United States comparable sales up 25%. Again, these types of numbers, I associate these with, like, Software-as-a-Service companies in normal times, [laughs] you don't expect Home Depot to have 25% growth in comps, but really good for them, they and Lowe's are executing, so they were sort of prepared in terms of inventory. They both have been working on their supply chain, so they were ready to shift more goods into stores. And I think that this really, again, proves the case for what you're talking about, Dylan, here is, buying best-of-breed can really pay off in the retail space.

One thing I want to point out for some listeners who might be looking at the gross profitability of Home Depot, its gross margin has been sort of flat-ish over the past couple of quarters, even as sales have exploded. For example, in this quarter that they just reported on, their gross margin slipped about 30 basis points. So, think a little less than a third of 1% to 34.2%. But you know, even before the pandemic, management had signaled that they just weren't that concerned about improving gross margins. Now, in most industries that would be a reason to run away from a stock, if management is consistently telling analysts, like, we're not that focused on [laughs] gross margin, we're improving it. But the deal is, again, sort of similar to the Costco model, because they sell so much merchandise. For Home Depot it's more about just dropping dollars to the gross profit line.

So, this last quarter, they increased their gross profit, not their profit percentage, but absolute gross profit dollars, by $2.1 billion. That's 22% growth in gross profit, and once you cover your fixed costs and what you need for some other general and administrative expenses, growth in absolute gross profit, again, drops down to the bottom-line, it drops down to net income, it manifests itself in free cash flow. Their operating cash flow this quarter was up $6.6 billion to $17.4 billion versus the comparable prior year period, so Home Depot is firing on all cylinders.

Lewis: And then Lowe's over here is like, oh, you think those numbers are good? [laughs] I've got something for you. Revenue up 28% year-over-year for Lowe's to $22.3 billion. Comps up 30%. I mean, that revenue growth number in retail, Asit, is typically what you see when a business or a concept is in the footprint expansion mode. They're opening new stores, and then you get that, you know, 20%, 30% revenue growth number, rare to see it for businesses that are so much more established like these, but it speaks to kind of where they are in terms of time and place.

Sharma: I think so. And it also helps that they keep so much inventory on premises in all of these stores. So, they had some time to replenish that inventory. But Lowe's especially, let's talk about for just a second, they have a relatively new CEO, they've been a perennial laggard behind Home Depot, but they're slowly turning things around. They've invested money in their internal inventory tracking, their distribution systems, their supply chains, so they're realizing the growth, they're taking some of that market share. I really love those numbers.

One thing to point out for investors who may be pouring over those results, you'll see that their net income actually decreased against the prior year quarter. This time last year, they had $1 billion in net profit, but in this quarter they just reported on, they hit net earnings of just under $700 million. Why? So, like Target, which I'm not sure we mentioned before, they retired some debt during the quarter, because their liquidity is improving, they're actually doing really well during the pandemic, so they had a big bond offering. They traded out some old debt for some new debt. And they took a charge of $1 billion to extinguish their debt.

Now, that sounds like a big number, [laughs] but over the life of these long-term loans, it works out better for them when you crunch the numbers to go ahead and retire that older debt for lower interest debt. So, they're taking a big charge today, but in the long-term, it's good.

I will point out that, for shareholders, they still managed to repurchase $621 million worth of shares and they paid out about $400 million in dividends. So, they also had $1 billion in shareholder-friendly actions this quarter. Lowe's has been an amazing story in terms of just turning itself around and going from sort of an afterthought to Home Depot to a viable investment competitor. So, really like how both these companies have performed.

Lewis: So, I know sometimes, when we talk about corporate finance and capital allocation, that eyes can glaze over a little bit, Asit. [laughs] And so, is it kind of fair to say that you can think of what happened with debt with Lowe's and Target, the same way that a homeowner might refinance a mortgage and take advantage of the fact that there are lower rates out there, pay less over the life of a loan?

Sharma: Absolutely. The thing that, with these big companies, is more of a sting, if you or I refinance our mortgage, Dylan, we're going to pay some closing costs, we're going to suck up [laughs] a little bit of, you know, cost to refinance that and save money over the long term. It often looks a lot bigger as a percentage on these companies' books, but many times they're working with, in some cases, floating rates of interest. And hopefully, you and I both went for a fixed mortgage where we got a predictable interest rate that's going to be fixed.

So, yeah, I think it's very similar to that, easy way to think of it. And for me, over the long-term, I love to see companies do this, especially when you've had to take on debt at the beginning of an unforeseen event, which is what most of these companies have done, they went to their bankers and said, we want to issue some debt and just make sure, in the worst case scenario, we get through this. And now we're finding that these strong retailers didn't need all that excess money, and in some cases, like I said, they're trading out older debt for newer debt, and just trying to clean up their balance sheets, in general.

Lewis: So, as we move to our last category here, Asit, we talked about the strength of e-commerce for the likes of Walmart and Target, we're going to be talking about Kohl's and TJX. And their relationship with e-commerce is a little bit different.

Sharma: It's a little more fraught. [laughs] Kohl's is a big-box store, but unlike some of the other companies that we've discussed, do-it-yourself, warehouse retailers, and then really diversified big-box retailers like Walmart and Target, they focus more on becoming a department store. They've had, like, a very big footprint; I'm talking about Kohl's.

TJX Companies, slightly different, in that they are spread across a few concepts, including the very famous TJ Maxx stores. I'm going to show my age here, because I well remember the jingle, you get the max for the minimum at TJ Maxx, which I'm sure very few viewers today [laughs] are even familiar with. But yeah, they've got that, they've got the HomeGoods stores. So, TJX is a little bit broader, but neither one of these companies has invested a lot of money in e-commerce.

Kohl's, because it was so focused on making sure that each of those big stores was profitable; and TJX, because they focus on a treasure hunt experience, where they're buying closeout merchandise all around the world, shipping it to their distribution centers, getting it into stores, giving you something new each week. And that model doesn't really work with e-commerce, because you're [laughs] changing inventory so frequently. And I think both of these companies were, sort of, blindsided. Dylan, Kohl's is down about 43% year-to-date, TJX is actually up, but not much, like, 3%. So, they've struggled during this period.

Lewis: Yeah. I think these are two slightly different struggles; at least the way I'm kind of looking at it. In Kohl's case, I mean, it feels like this was a business that still had a lot to figure out, even if you go back to late-2019. And that, you know, shares have not performed well in 2020, but they didn't start sliding in 2020, there were issues in 2019 as well. And I think what's hard is, particularly in the retail landscape that we're in, having a big footprint means that you're going to have a lot to pay for regardless of whether people are there or not. And we've seen a lot of experimentation with different footprint styles. But when you have that, it's this huge lingering cost that's going to be there no matter what comes in on the topline.

Sharma: Absolutely. We can give credit to management for, sort of, recognizing the problem. Some listeners may be familiar with steps that they took, like teaming up with concepts like Aldi. So, you mentioned, [laughs] Dylan, how tacking on a grocery element can be good for a retailer. So, Kohl's has some experimentation going on with just knocking down a wall and having part of that space flow naturally into a grocery store. They also did a really great job of just decreasing the space in their stores that was devoted to merchandise. So, it was very hard to notice, but they moved stuff closer together. What does that do? Well, that's less space that associates have to walk, it's less merchandise they have to carry in their stores. And they realize that it's better, in some cases, to have little bit of dead space than to try to fill space up with merchandise.

And you're right, though, they have been struggling with how to optimize what their footprint is. And although I say give management credit, they still hadn't solved the problems head-on before the pandemic came. I mean, that's why the stock has underperformed versus TJX Companies. I mean, they had a really brutal first and second quarters of this year. Store closures, just a slowdown in traffic, and a late entry into this world of having customers order online and then come to Kohl's parking lot and have it delivered to your vehicle; which we've done, as I mentioned before. So, I think they've been in a little bit of a bigger hole, but look at the quarter they just reported on, revenues down 14% year-over-year to $4 billion, but they had a surprise profit of $2 million. Now, [laughs] that's not a big profit, and that's on an adjusted basis as well, but I think investors were pleased to see that.

The stock had a really great day yesterday. They also paid off part of their revolving credit line, and they've got about $2 billion in cash on their books. So, things are looking up. I wouldn't say it's like a complete turnaround, and I am, for both of these companies, sort of worried about what's happening right now with COVID. I mean, it's spiking again.

The last thing I'll say that's positive about Kohl's is they've trimmed their inventory down to $3.6 billion; that's about $1.3 billion less than they had in inventory this time last year; that makes a lot of sense, because they're more streamlined -- they're not going to have a lot of excess inventory, so whatever they sell, they'll sell it with good sell through, it'll go quickly. So, I think that's positive as we head into the holidays. But still a little bit of ambiguity related to COVID with this retailer in particular.

Lewis: Yeah, and just to underline that point you're making about inventory, Asit. I mean, if you're in a spot where you're having people probably not coming as much or maybe not be spending quite as much, having a lot of inventory on hand exacerbates that problem, because it means at some point you got to liquidate that, and that's where TJ Maxx often comes in, right? [laughs] Maybe not directly from Kohl's, but you know, that's kind of where the supply chain of all that winds up flowing.

And so, you know, if you're in a spot where you have a ton of excess inventory, it's probably going to go out of style at some point or it's going to be out of season, and then, is it still going to be relevant 12 months from now? Probably not. Do you want to carry it all that time? So, them slimming down, right size them, kind of similar to how they're trying to right size the store footprint, and you certainly want to see it, because it just means they're going to be able to be so much more nimble in the coming months.

Sharma: Very much so.

Lewis: So, lastly, I think we'll just kind of touch on TJX. We've talked plenty about them, but I just want to put a couple of points on the earnings here and also just talk a little bit about the story, because I mean, for them, so much of the value prop is your treasure hunting, you said it before, but that's something that very uniquely insulated them from the likes of Amazon, it's kind of made them this Amazon-proof retailer. Unfortunately, when people can't go to the store, it means that they're going to struggle, because there is really no e-commerce footprint for them.

Sharma: It's pretty much the case. And I really like TJX as a concept. I think the management has executed really well over the years, and their global team that buys merchandise, they're just very experienced in what they do. Other concepts like this come and go, but TJX has a great team of buyers. And I think that they'll be in a position to rebound more next year. They are being very careful with how they manage their inventory as well. Their inventory is $5 billion going into this holiday season versus $6.3 billion this time last year.

One thing that I noticed in reading over their earnings report, and I think the stock is up, investors are reacting positively. So, sales were down 3.2% to $10 billion, their comps were down 5% for stores that have been opened. So, like-for-like. But their HomeGoods stores had 15% comp growth. So, HomeGoods is a newer concept, for those who aren't familiar with it, it is basically like a home furnishing store that's mostly what it does. There's a little bit of furniture in there, but this is a future growth concept for TJX companies, and that's a positive sign for them, it means they're competing well with a lot of other specialty retailers, they're taken some market share.

And you know, I see them rebounding a little easier than some of the other discount retailers that haven't done as well during this period. So, I'm keeping my eye on them, it's always a fun place to go in and shop, but I think it's going to be a fun stock as well in the next few years.

Lewis: Yeah, and what you're saying there, Asit, kind of fits this broader narrative, looking at all these companies, right? The strength in HomeGoods, because people are at home and kind of realizing that is probably going to be a relatively resilient part of the retail and consumer goods market for the foreseeable future. It's going to be hard to know when people have finally gotten their fill and everything [laughs] is the way they want them in their homes, but I think as far as we can see I think that's going to be a category that continues to do fairly well.

If we take a step back and look at these businesses and just kind of remind ourselves of where they were pre-COVID, I feel like with the exception of Kohl's, almost everyone was in pretty good shape. We were talking about quality before, pretty much all quality businesses. TJX, of the successful ones, seems to have been, kind of, blindsided by something that was maybe a vulnerability that we weren't even quite aware was there with that business.

Sharma: When you read through a company's annual report, they talk about the risks. And very few companies put pandemic risk [laughs] in that annual report. They will from now on. But I think you're right, Dylan, and the thing that I would love to add in here is that you identified something that separates these best-in-breed businesses from other businesses. You call this like a stress-test of really good business models. And I think we've seen all of these, with the exception of Kohl's, and they've actually, as the year has gone on, they've hit more of a stride.

You've seen these companies become stronger during the pandemic, definitely for Walmart, for Costco, for Lowe's, for Home Depot, you can clearly see how they benefited, and if anything, increased their loyal customer base. And I don't think that TJX Companies is far behind, and even Kohl's has been stress-tested, the fact that they were able to pay off some debt and have a better liquidity position this quarter shows that they are in better shape. So, that's a really great way to look at what is a best-of-breed company in retail, it's one that can survive a stress-test like this and get even stronger.

Lewis: Yeah. It's the same way that when we're talking about dividend stocks, we say, you know what, go back and look at the financial crisis. If they were able to weather the financial crisis, that dividend is probably going to be here to stay. I think people, five years from now, eight years from now, are going to be looking back at 2020 and saying the same thing, you know, were they able to continue their dividend policy? If you're a dividend investor, that's a good sign when it comes to a business.

Sharma: Definitely. And we should just mention that, both, Kohl's and TJ Maxx [TJX] (sic) are reinstating their dividends. TJX Companies, parent of TJ Maxx, is going to start in December with its next dividend, it's going to resume in December. And Kohl's said that it'll start in the first-half of 2021.

Lewis: Asit, this wound up being like a sleeper income investor episode. [laughs]

Sharma: It is. [laughs] And that's the nature of these stocks, they're sleepers. But boy! When you look back, just as you had said in our notes, Dylan, one year, three years, five years, seven years, they start to look so good [laughs] and you wonder why you didn't take a position in them earlier. [laughs]

Lewis: [laughs] Well, we can get together again soon, and mourn together, Asit, it's always --

Sharma: Yeah, we commiserate together [laughs] ...

Lewis: laughs] Yeah, it's fun to commiserate with you. Thanks so much for hopping on today's show with me.

Sharma: Thanks, it was a blast, I appreciate it, Dylan.

Lewis: Listeners, that's going to do it for this episode of Industry Focus. If you have any questions or you want to reach out and say "Hey!" shoot us an email over IndustryFocus@Fool.com or you can tweet us @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes or wherever you get your podcasts.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear.

Thanks to Tim Sparks for all his work behind the glass today, and thank you for listening. Until next time, Fool on!