ROST and TJX: Recession-proof retailers

Two of the strongest retailers I know in the US are ROST and TJX. The business model is simple: buy branded goods by the truckload at dirt-cheap prices, and sell them at a discount to the department store prices. All but the most premium brands have a tendency to over-produce. ROST and TJX buy merchandise when department stores need to "close out" items. They then hold or distribute them to their outlets and sell them at large discounts.

Because the inventory is very eclectic (a full selection of sizes and designs is not available), it creates a "treasure-hunt" like environment in the store. From personal experience, females in my household love shopping at Marshall's (owned by TJX) and Ross Stores (ROST) "you never know what you may find." (I guess we are a family of "value" investors).

These two publicly traded companies are killing it and the numbers do not lie:

ROST

EPS 2007 - 2017: 0.42 - 2.72 (21% CAGR)
Net Income 2007 - 2017: 242 - 1081 (16% CAGR)
Shares Outstanding 2007 - 2017: 568 - 398 (-3% CAGR)
Store Count 2007 - 2017: 890 - 1446 (5% CAGR)
Payout %age 2007 - 2017: 15% - 20%
Return on Equity 2007 - 2017: 27% - 42%
Net Margin 2007 - 2017: 4% - 8%

TJX (2007 - 2017):

EPS: 0.78 - 3.41 (16% CAGR)
Net Income: 738 - 2287 (12% CAGR)
Shares Outstanding: 960 - 669 (-4% CAGR)
Store Count: 1623 - 2223 (3% CAGR)
Payout %age: 17% - 27%
Return on Equity: 35% - 52%
Return on Assets: 13% - 18%
Net Margin: 4% - 7%

These numbers are excellent. I am really surprised that both these retailers have thrived in our competitive, capitalist world without attracting a lot of competition. Side note: I have noticed another slightly higher-end off-price retailer in my local area called Fox's. I will be keeping an eye on when it goes public.

What's even more impressive is that both these retailers increased Net Income and EPS during the 2008-9 recession. This business model really is superior to "regular" retailing branded clothing/accessories.

How/Why did the growth come about over the past 10 years?

Net Income growth can be attributed to store count growth, same store sales growth and margin expansion. For ROST, these 3 factors contributed roughly 5% CAGR annually.

The "why" is the most important question but I do not have any good insights into why competition hasn't moved in to eat the lunch that TJX and ROST are enjoying. I suspect a combination of these comprise of the competitive advantage:

1. Scale advantage. About 10 years back, the net margins of TJX and ROST were 4% and now they are at 8%. An incumbent would have lower net margins than 4% at the beginning. I suspect this keeps competition out.
2. Established relationships with branded department stores. An incumbent will need to build these relationships again from scratch.

The Future (next 10 years)

Where will things be 10 years from now?

I think ROST store count could be will be around 2200 (4% CAGR). Net margin will be 10% due to higher operating leverage (2% CAGR). Same store growth will be 2% CAGR (totally made up). Therefore Net Income should compound at around 8%.

To compute total return, we need to add dividend yield (1%) and buyback yield (3%) for a total of 11% total CAGR over 10 years (assuming valuation doesn't change).

Management

This is a noticeable dark halo around these two companies. Management compensation is, IMHO, excessive. ROST pays its executives 35M out of 1B total profit, which is 3% "management fee." TJX pays 60M from 2.3B total profit which is also around 3%.

I wish management paid itself less than 3% (something like 1% seems reasonable to me), especially because forward returns don't seem very high compared to the past. But then again, most companies are not like CHKP (where the CEO makes minimum wage).

Valuation

Currently selling for 24x trailing and 21x forward P/E. I suspect valuation will decrease over the next 10 years which will dampen total return.

From the universe of retailers, these would be good candidates to hold in a portfolio.

Subjective Thoughts on the Business Model

I like businesses that create value in the world. Most successful, sustainable businesses in the world create a lot of value for their customers. These two businesses certainly create the world a better place. Without ROST and TJX, department stores would be forced to trash their excessive inventory. Consumers who love to wear branded goods may also be forced to pay a high price for them. ROST and TJX enable "value" consumers to wear branded clothing, etc. at a fair price. It's a win-win for everyone.