Brick-and-mortar retail has been struggling in recent years as consumers increasingly turn to online shopping. In fact, e-commerce sales have grown seven times faster than brick and mortar retail since 2005 (14% annually vs 2%).
That being said, brick-and-mortar shopping is far from dead, with most physical stores still seeing slow but steady growth in recent years.
Among traditional retailers, TJX Companies (TJX) in particular has proven itself to be arguably the best in the industry thanks to:
- An impressive 28-year dividend growth rate of 14.7% annually
- 21 consecutive years of dividend increases (TJX will become a dividend aristocrat in 2021)
Market-beating returns over the last two decades (23.1% total returns vs 9.1% for S&P 500)
Let’s take a look at what makes TJX so special and why its business model seems likely to continue to do well even in the age of Amazon (AMZN).
More importantly, find out if today could be a reasonable time to potentially add this fast growing future dividend aristocrat to a diversified income portfolio.
Business Overview
Founded in 1956 in Framingham, Massachusetts, TJX Companies is the world’s largest off-price (i.e. discount) retailer with more than 4,000 stores in nine countries on three continents (United States, Canada, the United Kingdom, Ireland, Germany, Poland, Austria, the Netherlands, and Australia).
The company’s stores operate under the T.J. Maxx, Marshalls, HomeGoods, Winners, HomeSense, T.K. Maxx, and Sierra Trading Post brands (and three e-commerce sites). TJX has four operating divisions:
TJX YTD Sales and Operating Earnings
Source: TJX earnings
Despite its growing diversification, 77% and 83% of the company’s revenue and operating earnings, respectively are still derived from the US.
Business Analysis
Retail is a notoriously cyclical and challenging business thanks to high economic sensitivity, shifting consumer trends, and cutthroat competition leading to low margins. However, TJX has managed to drive very impressive growth over the years, in all manner of economic environments.
For example, the company’s same store comparable sales (comps), which apply to stores open at least a year, have been positive in 33 of the last 35 years, meaning that even during recessions TJX has seen rising sales and foot traffic in its establishments.
Source: TJX Companies
The company’s impressive resiliency is thanks to its off-price business model, in which the company acquires excess inventory from name brands (that would otherwise have to be written off at a loss), and then sells them at a 20% to 60% discount. TJX prides itself on offering a “treasure hunt” experience, with a constantly changing inventory of popular products and apparel that keeps its customers coming back again and again. This is seen via the company’s store layouts, which have no internal walls and most products in wheeled bins and on racks that can be easily moved around to accommodate changing seasonal and fashion trends.
However, the real key to TJX’s success is the way it’s built up a massive supply chain, consisting of more than 1,000 purchasing agents in 11 countries who purchase products from over 18,000 suppliers in more than 100 countries. What TJX does, and what gives it a moat in an otherwise no moat industry, is leverage its enormous capital base to source a wide assortment of products at rock bottom prices (and below that of rivals). There are two main reasons why TXJ is able to do this.
First, TJX has a proprietary inventory management system that uses complex store-level data analysis to determine what local customers want most. This allows the company to purchase a wide array of products from suppliers and offer far better terms than most of its peers can offer.
This includes:
- Less than full assortments (odd lot sizes) of products
- No marketing or delivery concessions (TJX will pick up the products itself via its massive supply chain)
- No return concessions
- Prompt payment in cash rather than paying on credit
In other words, TJX’s massive size and access to capital mean that it is often the best partner for its suppliers to sell to. The company’s highly diversified store base is capable of absorbing a large amount of various products and turning them over quickly (TJX’s total inventory turnover time is an industry-leading 57 days).
The company’s economies of scale, tech-driven innovation, and supply chain and inventory management have allowed it to consistently deliver some of the best margins and returns on capital in the industry.
That includes a very healthy free cash flow margin (which ultimately funds the dividend). Note that TJX’s high returns on equity and invested capital (debt + equity) are skewed upwards by the large amount of stock it buys back each year (14% of total shares outstanding during the past five years). Accounting standards require this to be held as “treasury stock” on the balance sheet which lowers shareholder equity and thus inflates these metrics. However, this is merely an accounting effect, and the company’s adjusted returns on invested capital are still 28%, far above the industry average and very impressive for a retailer.
TJX Trailing 12-Month Profitability
Sources: Morningstar, Gurufocus, CSImarketing
More importantly, TJX’s management, led by Chairwomen Carol Meyrowitz and CEO Ernie Herrman, have very long track records of successfully adapting and growing in the retail sector. They’ve been with the company since 1987 and 1989, respectively, and have proven to be excellent capital allocators and very friendly to their investors. That includes aggressively returning cash to shareholders in the form of buybacks and growing dividends.
Source: TJX Investor Presentation
However, the company’s substantial returns of capital don’t mean that TJX isn’t still investing in growth. In fact, the company plans to increase its store count by about 1,600 in the coming years (in just its existing markets), including a 50% increase in US store count (about 6% annual domestic store count growth).
Source: TJX Investor Presentation
The bottom line is TJX has proven that its discount retail business model, combined with industry-leading execution and competitive advantages in supply chain, management inventory, and product pricing, can make it one of the best-managed and fastest-growing global retailers.
More importantly, TJX has thus far proven to be largely Amazon-proof while showing an exceptional dedication to large dividend increases that make it an appealing choice for a growth-focused income portfolio. That being said, TJX, like all retailers, still faces numerous challenges that should be closely considered.
Key Risks
While TJX has had an amazing run in the past few decades, successfully adapting to changing and challenging industry conditions, there are still numerous risks to consider.
For one thing, TJX’s success in off-price retail has attracted increasing competition, including from Ross Stores (ROST), Kohl’s (KSS), Burlington Stores (BURL), and Nordstrom (JWN). Thus far only Ross Stores has been able to replicate its success with any degree of sustained profitable growth. However, over time the growth of rivals also sourcing excess name brand merchandise means that TJX might find it more challenging to get enough inventory to satisfy customers at an ever increasing number of global stores.
In addition, there’s always the risk that the company’s aggressive expansion plans, especially in the US, could leave it overstored, which has been a huge issue for numerous brick-and-mortar retailers in recent years. There are already potentially troubling signs that this might be the case.
For example, in the last quarter Marmaxx (TJ Maxx and Marshall’s) reported -1% comps, and year-to-date comps are up just 0.3%. That’s compared to 5% comps growth in the same time period last year. The good news is that some of this is due to the recent hurricanes and unusually poor weather nationwide, and the company’s other segments have continued to report positive comps, including:
- International: +1%
- HomeGoods: +3%
- Canada: +4%
This indicates that the company’s recent weakness could indeed be transitory. After all, since 1982 global comps have varied between -2% (1996) and 27% (1982). That being said, we can’t forget that the ultimate value proposition that has served off-price retailers so well (“treasure hunt” experience and deep value) is the cornerstone of what has led to the success of e-commerce giants such as Amazon.
In other words, Amazon’s entire business model is based on using its increasingly detailed database of consumer preferences and past shopping experiences to learn what its customers want, and then bring them potentially attractive items at the lowest possible price. TJX is going to have to continue innovating and expanding its own online presence in order to compete for the same value-centric customers that have been its bread and butter for so many decades.
Furthermore, TJX’s foreign stores, while a good source of diversification and future growth, are also a potentially double-edged sword for two reasons. First, as its non-US business grows, TJX will be facing increasing currency risk.
Should the US dollar strengthen relative to the Canadian and Australian dollars, the British Pound, and the Euro, the company’s sales (and earnings) in those regions would translate to lower US dollars for accounting and dividend payment purposes. Rising US interest rates, relative to lower rates in these other countries, could be a catalyst for such currency appreciation.
The other issue TJX faces with overseas growth is that its international stores have thus far proven to be far less profitable than its US operations. For example, here are the operating margins of its various segments.
- TJX International: 4.0%
- Homegoods: 13.0%
- Marmaxx: 13.5%
- TJX Canada: 15.4%
There’s both good and bad news on this front. The bad news is that when TJX enters a new country, it’s stores have relatively low profitability because the company has to recreate its impressive supply and distribution chain in that region, which can take a long time. However, the good news is that, as the impressive operating margins of TJX Canada (the company’s first foray into non-US stores) demonstrate, the company has proven that it can recreate its impressive high-margin business model elsewhere.
The final risk to consider is the ongoing issue of rising labor costs, both from numerous states (and foreign countries) raising their minimum wages. For example, in England, which accounts for about 66% of TJX international stores, the minimum wage is being increased 7% over the next five years. Meanwhile in the US, 21 states, DC, and 40 cities have raised their minimum wages since 2014, including several that are gradually mandating $15 per hour. TJX estimates that rising labor costs will represent a -2% EPS growth catalyst for the next few years as these higher wage requirements are phased in.
The company is counting on an aggressive pace of store expansion, and likely long-term comps growth of 3%, in order to be able to continue generating strong earnings and free cash flow growth in this environment. However, should the recent weakness in US store comps persist, then these rising labor costs could end up causing earnings, cash flow, and dividend growth rates to come in far below the company’s historical norms and what investors currently expect.
That being said, few other companies have proven themselves as adaptable and shareholder-friendly as TJX in the world of retail. While the risks facing TJX are real and could threaten its long-term stroe expansion plans, the company still represents one of the top names in retail dividend growth stocks. That’s particularly true thanks to its excellent dividend safety.
TJX’s Dividend Safety
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.
TJX has a Dividend Safety Score of 84, indicating a very safe and dependable dividend. That’s not surprising since TJX is a dividend achiever, and with 21 straight years of annual payout increases (the next one is expected shortly), is set to become a dividend aristocrat in 2021.
Source: Simply Safe Dividends
There are three keys to TJX’s strong dividend safety and payout growth over time. First, the company has been very good at quickly growing its earnings and free cash flow per share, courtesy of its increasing profitability (from rising economies of scale) and aggressive share buybacks.
Source: Simply Safe Dividends
Next, the company has been careful to grow its dividend at a conservative pace, thus ensuring that its payout ratio remains low and creates a strong safety buffer for the dividend in case economic conditions turn unfavorable.
Source: Simply Safe Dividends
The final reason for TJX’s rock solid payout security is the company’s excellent balance sheet, which poses to risk to the dividend and should provide TJX with plenty of access to cheap financing if it ever needs it.
Source: Simply Safe Dividends
Note that the retail industry is very capital intensive thanks to its large inventory costs, which makes TJX’s net cash position extremely impressive. The company’s financial situation looks even better when we compare its debt metrics to those of its rivals.
For example, the company’s leverage ratio (Debt/EBITDA) is less than 25% of the industry’s average. Meanwhile, TJX’s current ratio (short-term assets/short-term liabilities) is more than three times greater. TJX’s interest coverage ratio is also among the best in the industry. That explains why TJX has a very strong investment grade credit rating that allows it to borrow at an average interest rate of just 2.9% (only 0.4% higher than a 10-year US Treasury).
Sources: Morningstar, Fastgraphs, CSImarketing
In other words, TJX’s skilled and disciplined management team runs a very tight ship. This means not only an impressive ability to consistently grow earnings and cash flows, but also a conservative approach to retaining large amounts of cash to maintain a very safe level of debt that should never jeopardize the company or its dividend. All of these factors ensure the company can continue to invest aggressively in growth while still providing a highly safe and fast-growing dividend.
TJX’s Dividend Growth
TJX has become a dividend growth rock star, with long-term payout growth rates in excess of 20% annually.
Source: Simply Safe Dividends
Going forward, the company will likely have to grow the dividend slower, in line with earnings and free cash flow, in order to continue maintaining its low payout ratio while retaining enough cash to achieve its store growth ambitions.
Fortunately, analysts expect TJX’s future revenues to grow about 7% annually over the long-term, courtesy of 3% comps and 1,600 more store openings. Combined with ongoing cost cutting (supply and logistics chain optimization via technology) and about 2% a year in stock buybacks, earnings and free cash flow per share could grow around 11% to 13% annually for the foreseeable future.
This means that investors can likely expect around double-digit dividend growth over this time, which is among the fastest levels offered by any retail stock.
Valuation
Over the past year concerns over slowing comps growth and doubts about the company’s long-term store expansion plans have caused TJX shares to underperform the S&P 500 by more than 20%.
However, because the company’s earnings and dividends continue to grow, TJX’s valuation has begun to look more attractive for investors who believe in the company’s unique business model and the health of this brick-and-mortar niche.
More specifically, TJX’s forward P/E is now 17.8, which is slightly below the S&P 500’s 18.5 ratio and the stock’s historical norm of 19.0.
It’s worth mentioning that TJX’s dividend yield of 1.7% is also meaningfully higher than the stock’s five-year average yield of 1.2%.
However, TJX’s long-term earnings growth rate will ultimately play a much larger role in determining the stock’s total return from here, and a higher dividend yield is to be expected from a company with a potentially maturing growth profile.
Source: Simply Safe Dividends
TJX shares bought today have potential to generate 11.7% to 14.7% annual total returns (1.7% dividend yield + 10% to 13% annual earnings growth) over the coming years if everything goes right, which would be among the best potential return profiles available in today’s overheated market.
The million-dollar question is whether or not TJX’s store expansion plans are possible in a shrinking brick-and-mortar world. Investors are clearly skeptical based on how the stock looks priced today, but that could also be creating opportunity for investors who are more bullish on the off-price retail space.
Conclusion
Retail is a very tough industry that’s currently undergoing a lot of disruption. Naturally this makes dividend investors nervous about the safety and growth prospects of many retail stocks (see our past analysis on Macy’s, for example).
However, TJX Companies has proven one of the best managed and most adaptable retail companies in the world over the last few decades. Its deep discount business model and strong focus on an exciting customer shopping experience have thus far proven to be fairly resilient to the rise of e-commerce.
Given the stock’s underperformance in recent years, TJX’s valuation is beginning to look pretty interest as its earnings and cash flow continue expanding. Investors who are comfortable with the long-term risks facing the industry and who don’t have an immediate need for high-yield (say to live off dividends during retirement), today could be a reasonable time to give this quality dividend growth stock a closer look.
Brian Bollinger
Simply Safe Dividends
Simply Safe Dividends provides a monthly newsletter and a comprehensive, easy-to-use suite of online research tools to help dividend investors increase current income, make better investment decisions, and avoid risk. Whether you are looking to find safe dividend stocks for retirement, track your dividend portfolio’s income, or receive guidance on potential stocks to buy, Simply Safe Dividends has you covered. Our service is rooted in integrity and filled with objective analysis. We are your one-stop shop for safe dividend investing. Brian Bollinger, CPA, runs Simply Safe Dividends and previously worked as an equity research analyst at a multibillion-dollar investment firm. Check us out today, with your free 10-day trial (no credit card required).
Source: Simply Safe Dividends