With the recession still in the air, everyone is always looking for a deal when it comes to food, electronics, even clothing.

Companies such as T.J. Maxx and Marshalls are dominating the space and seeing returns that are typically unheard of in the off-price retail market. But with Macy's (NYSE:M) having birthed Bloomingdales, which shows more promise when it comes to investing? Although TJX (NYSE:TJX) is booming while hunting for additional locations to build, Macy's still has a leg up that keeps it a major player in the retail jungle.

A full transcript follows the video.


Sean O'Reilly: We're going shopping for discount clothing, on this consumer-goods edition of Industry Focus.

Greetings, Fools! I am Sean O'Reilly, joining you here from Fool headquarters in beautiful Alexandria, Va. We're probably going to touch 100 degrees today, so I'm totally staying inside. Today we're talking about discount retail, and I'm joined a Motley Fool contributor and awesome writer. I hope you guys have read his stuff -- Adam Levine-Weinberg. How are you today, Adam?

Adam Levine-Weinberg: I'm great. How are you?

O'Reilly: Not too shabby. So you're out there in Chicago right now?

Levine-Weinberg: I am.

O'Reilly: How are things in the Windy City?

Levine-Weinberg: It's been good. It's actually been pretty chilly out here.

O'Reilly: Really?

Levine-Weinberg: Surprising for summer, yeah.

O'Reilly: Got some cool air breezing in over Lake Michigan there?

Levine-Weinberg: Yeah.

O'Reilly: Very good. Well, go, Cubbies, huh?

Levine-Weinberg: Exactly.

O'Reilly: Very cool. So we're talking about off-price retailers. For our listeners who don't know what that is, we'll define it in a second. It's not necessarily Amazon.com (NASDAQ:AMZN) and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and eBay (NASDAQ:EBAY) versus the department stores of the world, but it's really off-price retailers like T.J. Maxx versus [Sears Holdings (OTC:SHLDQ)] and J.C. Penney (NYSE:JCP). So why is off-price retail so important, and what are some basic stats for investors?

Levine-Weinberg: People talk a lot about the death or disruption of big-box retailers. Usually they're talking about the rise in e-commerce, especially the rise of Amazon.com. To some companies like Best Buy (NYSE:BBY), Amazon probably is -- by far -- the biggest threat, because you have products that you don't need to see it, or if you do need to see it in the store you can go there and get on your Amazon app and order it while you're standing in Best Buy.

O'Reilly: Yeah. I needed an HDMI cable for my TV, and I just knew exactly what I needed. I went to Amazon.com, I ordered it, and two days later I had it. There's no differentiation at all.

Levine-Weinberg: Right. So Amazon is still a threat for department stores, but it isn't its biggest threat. If you just look at the numbers, Amazon's annual sales surpassed $90 billion, which is a huge number, but for clothes and accessories it's only about 6% of Amazon's total business. They sell a lot more, even in the media sales, which is kind of where they got their start in books, music, movies, and then a ton in electronics.

They're even getting into groceries, but fashion is still a relatively small part of their business. That's about 5 or 6 billion for them. Part of the reason is people do like to be able to try on clothing before a buy. Not everybody, but ...

O'Reilly: It's a big risk. You don't want to ...

Levine-Weinberg: Most of them, most of the time.

O'Reilly: Yeah, and it's a risk. You don't want to pay to return it with shipping and everything.

Levine-Weinberg: Yeah. Even if the returns are free, it's a hassle. So it's easier to walk in somewhere, look at a lot of stuff, and pick out a few things.

O'Reilly: It obviously lends itself to a bull case for the big retailers, but obviously they've got some competition coming from T.J. Maxx. What kind of stats have we seen there?

Levine-Weinberg: Just over the past seven or eight years since the Great Recession, we've seen a huge sea change in the retail landscape, specifically for clothing and accessories. Also in home goods, whether that's sheets, furniture, etc. If you look at 2008, Macy's had $26 billion of sales, J.C. Penney was around $20 billion, TJX -- they're the biggest off-price retailer, and they're the ones that own T.J. Maxx and Marshalls and HomeGoods -- they have about $18.5 billion. Kohl's (NYSE:KSS) is right behind them with $16.5 billion.

At that point, Kohl's is growing very quickly. If you look today, TJX is now the biggest company in that whole industry, with nearly $30 billion in sales. It's up about 60% just in the last seven years or so. Macy's has basically flatlined. They're up about $2 billion to $28 billion; Kohl's also up $2.5 billion to around $19 billion; and meanwhile, J.C. Penney has lost about a third of its business and is down to $12.5 billion in sales. For J.C. Penney, they're getting caught by Ross Stores (NASDAQ:ROST), which is a smaller off-price chain, but they're already up to $11 billion in annual sales -- which is up 85% just since 2008.

So there's been a huge share shift, and it's continuing. These companies like TJX and Loft stores are growing at a high-single-digit rate, whereas the overall retail sales is growing very slowly. When they're growing at that rate, they're basically taking sales from other people. If you look at their long-term store plan, TJX is about 2,600 locations in the U.S. today, and it sees long-term potential for at least 4,000 stores in the country, maybe more. They keep raising their projections almost every year.

O'Reilly: What's your opinion on that? I hear 2,600 and I'm like, "Oh, boy. Are they reaching the saturation?" Because I see one in every major city I go to. What's your gut on that?

Levine-Weinberg: I think they still have room to grow. If you look at their in-store sales figures, they keep adding locations and growing their square footage by about 4% or 5% a year. The same-store sales are still growing about 3%, which isn't tremendous, but it's certainly very adequate. It means that more people are coming into each store. It means they're not really cannibalizing; they're just doing business by opening new stores.

It certainly seems like they have room to grow, whether it's entering a few markets where they don't exist, or densifying their store layout. As I'll talk about later, convenience is one of their big selling points. So if they're five minutes away instead of 15 minutes away, they'll get more shoppers.

O'Reilly: Yeah. How do I phrase this? In your opinion, why is off-price retail so successful? You look at the return-on-equity numbers for TJX and Ross; over the last five years TJX has averaged around 44% to 52% annual returns on equity. That is insane. That does not happen. That is multiples of what the average U.S. public company does. Ross is still in the 40s; even a Buffett favorite -- Coca-Cola (NYSE:KO) -- is in the low 30s. This should not happen in such a competitive business like retail.

Levine-Weinberg: Yeah. I will approach from two perspectives. The first is from the value of product to consumers. Obviously, a big factor in driving business toward these off-price retailers is simply price. They have a big discount compared to department stores, and they do that in part by keeping their costs down. They have much smaller and less elaborate spaces, whereas a big department store could be 150, up to 300 thousand square feet.

If you're going to flagship store like the Macy's store in Herald Square, you're looking at 1 million square feet. These are massive stores and are [made] to make you feel like you're having a luxury experience, at least for the mid- to high-end retailers. You go into a T.J. Maxx store; it's very ... tends to be about 3,000 square feet, and there's big savings there. They have a more opportunistic buying strategy.

Whereas a full-line retailer like Macy's will go well in advance and buy all different sizes, colors, styles from a particular designer, T.J. Maxx can go in and find out, "This particular designer made too much of something, and they're offering it at a great deal." And they'll buy it, or at the year end they made too much this year, and at the end of the season the retailers want to get rid of them.

So they can buy and pack it away and hold it for the next year and put it out when it comes back into season. They have a lot of different strategies they can use to get merchandise that is still much cheaper than what the department stores are paying.

O'Reilly: How are Saks and Macy's and Kohl's and J.C. Penney getting in on this? They obviously see what's happening.

Levine-Weinberg: Yeah. Obviously, department stores see an opportunity here. A few of them have already been pretty successful at off-price. If you look at Nordstrom (NYSE:JWN), that's probably the biggest case of a retailer that's figured out how to do full price and also do off-price. As of a couple years ago, Nordstrom Rack -- which is the discount off-price version of Nordstrom -- passed the full-line Nordstrom in terms of number of locations.

O'Reilly: Yeah, I'm sure both our wives love Rack.

Levine-Weinberg: Yeah. Off-price numbers at Nordstrom have tripled since 2008 from $1.2 billion to $3.6 billion by last year. Nordstrom still sees plenty of runway to grow. They ended last year with 167 Nordstrom Racks, and they plan to open another 27 this year to reach 300 in the U.S. by 2020. They also think they can expand that into Canada and maybe elsewhere in the long run. Off-price is now 27% of Nordstrom's total business, even though they've been doing the full-line thing since the early 1900s. It could easily get up to 35%, or even 40% in the next five years. You also see people like Saks Fifth Avenue who have gone down the same road. They have twice as many off-price stores as their full-line stores.

Now [other retailers] are moving in. Macy's recently announced the pilot of their new off-price concept, which is going to be called Macy's Backstage. They've already picked six locations, all in the New York metro area, to open this fall, and they're going to see how it does and test it, refine it, and probably roll it out nationwide.

Macy's already has some experience in off-price because they also own the Bloomingdales chain, which is more upscale. Bloomingdales has an outlet business, which is basically an off-price version. Then even Kohl's got into the game recently. They're going to open off-price concept store called Off Aisle by Kohl's. That's going to be in New Jersey.

O'Reilly: Wow. These are great names, by the way. Macy's Backstage, and stuff.

Levine-Weinberg: Yeah.

O'Reilly: Respect there. Just wrapping up, this is The Motley Fool -- we try to figure out how to invest for the long term and everything. How do I get in on this? Is there anything to stop this? Should I just buy shares in Ross and T.J. Maxx and call it a day? What's the long-term gain here?

Levine-Weinberg: Yeah. I think T.J. Maxx is a best-in-class retailer, and I think you can't go wrong with their stock. It's a little pricey, but not overly so. If a company has shown that it can consistently grow its sales year after year by 6% or 7%, they also have returned a ton of cash to investors, they're buying back about 50% of their stock year in year out -- that leads to solid double-digit earnings, ETF growth over the long term. I think Nordstrom is also a great stock to play on this, because Nordstrom Rack has already been very successful, and they clearly have a lot of runway to keep growing that concept.

As for the other chains that are trying to get in, I think there's a good chance that Macy's will be successful. I'm a little less certain about Kohl's. J.C. Penney had a chain of outlet stores that was sold off a few years ago for pennies. They sold it for less than what the inventory was worth. The chain still went out of business a couple years later. There have been a couple of other high-profile bankruptcies in the off-price space in the past few years. Syms, [which] also owned the Filene's Basement chain, had to liquidate a few years ago, and a little over a year ago, Loehmann's was another off-price retailer that liquidated.

It's definitely a very valuable business model if you get it right. I think it's important to stick with the companies that are already getting it right, because there are others that have shown it's not a sure thing. You can't just open a bunch of off-price stores and voila, you have these 40% returns in equity and giant profits.

O'Reilly: Awesome. Very good. Thank you for your thoughts, Adam. Go catch a Cubs game for me, OK?

Levine-Weinberg: All right. I will.

O'Reilly: Have a good one.

That is it for us, Fools. Before we go, I want to make our listeners aware of a very special offer for all our Industry Focus listeners. If you found this discussion informative, and you're looking for more Foolish stock ideas, Stock Advisor may be the service for you. It is our flagship newsletter, started more than 10 years ago by Motley Fool co-founders Tom and David Gardner. We're offering the lowest price out there for all of our Industry Focus listeners. It is $98 for two a two-year subscription to Stock Advisor. You will get two stock recommendations every month with insight from our team of analysts. Just go to focus.fool.com to take advantage of that deal. Once again, that is focus.fool.com.

As always, people on this program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against those stocks. So don't buy or sell anything based solely on what you hear on this program. For Adam Levine-Weinberg, I'm Sean O'Reilly. Thanks for listening, and Fool on!