The recent credit card breach at TJMaxx has evoked loud criticism from all corners of the investment and political spectrum over the company's lax security measures. Some have gone as far as to equate the companies actions as those of the criminals themselves. In a recent Lightening Round on Cramers Mad Money, when asked his view of the stock, Jim declared that TJX is a "mismanaged" company. Perhaps had he given more than the 12 allotted seconds to deliberate each stock idea, he may have constructed a more thoughtful position.
While I am concerned that more stringent controls were not in place before the breach, I view TJX as more a victim than culprit in this situation. I love when short term issues like this give us the opportunity as long term investors to buy and hold great companies until the market lets them out of the penalty box. I must say, I have to respectfully disagree with Cramer’s conclusion however that TJX is a “mismanaged” company. Having done significant work on the drivers of outperformance in the retailing space, I have concluded that the winners are usually the companies that #1 can generate the highest return on shareholders capital & #2 can sustain strong “same store sales”
Because TJX employs a unique business model that emphasizes operating highly efficient stores and delivering value to the consumer and focuses less on developing fancy store layouts and concepts, they consistently earn higher return on invested capital than their peer group. TJX turns its inventory much faster than most peers, which creates value in three important ways. The faster inventory turnover enables TJMaxx to generate higher levels of cash flow as less working capital is needed to finance the inventory. Capital expenditures also tend to be lower as store concepts are lower priority, and stores do not need to be renovated every three years to remain "trendy", As the chart below illustrates, TJX has one of the highest levels of free cash flow earning power in the retailing sector, a financial metric which is typically associated with higher valuations and stock prices. Secondly, the brisk turnover model creates huge value proposition for its suppliers, providing the clothing manufacturers and department stores an additional channel of distribution and allows them to optimize their merchandising. Finally, the model lowers the financial risk profile for TJX as fashion risks are minimized.
It is difficult, in the long run, to make money on stocks that have high fashion risk, companies that can often be victim to consumers rapidly changing tastes, i.e. the Gap, Krispy Kreme, and Cramer’s favorites like Crocs and Under-Armor. Sure, some will succeed, but getting the merchandise strategy right is another uncontrollable variable in the mix.
TJX has much less risk because if it makes a fashion blunder, it has much shorter lead-times and can quickly adjust its merchandising. Other companies could have several quarters of earnings misses if it makes poor merchandising decisions as purchasing decisions are made several months in advance.
In terms of growth, TJX has strong unit growth potential in some of its newer concepts, but more importantly it grows its “same store sales” much more consistently than most retailers. The attached charts show how TJX has a very loyal customer base (we call them “treasure hunters”) and in fact in slowing periods TJX tends to attract marginal customers that trade down from higher-end retail.
These are signs of very solid management and I remain confident that over our longer frame investment time horizon, this thesis should materialize and we will see a solid return.
