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Why These Apparel Retailers Continue to Grow

October 11, 2013 | About:
patokehoe

patokehoe

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Over the past few years, economic uncertainties in the U.S. have created a large market for low priced goods. As customers’ preferences have shifted heavily towards cheaper products, discount apparel retailers such as Ross Stores Inc (ROST) and TJX Companies (TJX) have seen large growth rates. Both companies have been carrying out similar strategies, in order to offer brand-name merchandise at a discount. However, as some differences exist, I intend to uncover what sets these apparel retailers apart.

Discounts and Scaling

Ross Stores is a large off-price apparel chain operator in the U.S. that sells designers apparel at its 1,131 locations. The firm caters to middle-income consumers, at prices that are around 20%-60% below regular prices. Unlike other retailers, Ross has been able to expand its customer base during the recession, posting a three year average revenue growth of 11%. As this trend is expected to continue, investment guru Scott Black, of Delphi Management, recently increased his stake in the company.

The recovering U.S. economy has led consumers to seek price discounts, while leaving aside customer service and store design. Offering large discounts on brand-name merchandise has allowed Ross to acquire and maintain an additional market share. Since the firm achieved an impressive growth rate over the past years, opportunities for additional growth should arise in a more positive economic environment. By opening clusters of new stores in markets, where it can achieve operational advantages, the firm is executing its internal growth strategy wisely. Also, the significant scale with which Ross operates is supported by a large buying force, warehousing, and distribution network. The firm’s scale will enable it to continue offering lower prices and higher quality merchandise.

The discount apparel retailer has benefited from one distinct advantage, that is, it can cater to customers’ economic uncertainty. As the uncertainty remains, discounts attract more consumers and lead them to abandon full-price retailers in favor of Ross. Also, since the firm is currently trading at 19.1 times its trailing earnings, it does not entail a significant price premium relative to the industry average. Ross seems like a savvy investment with low risk, and hence, I feel bullish about this stock.

International Expansion

TJX competes directly with Ross in the discount retail segment. Yet, it operates twice as many stores in the U.S. It owns around 2,400 shops domestically and another 700 stores in Canada and Europe, giving it a degree of international exposure its rival does not possess. The company’s revenue growth is expected to remain strong as new expansion opportunities arise.

TJX has been growing domestically and internationally, in both, favorable and hostile economic environments. The company’s ability to generate free cash flow has resulted in a 10-year average return of 7% on investments, a rarity in the retail industry. Much like Ross, TJX offers brand-name merchandise at a large discount, due to competitive advantages in scale and inventory management. However, its expansion opportunities are not limited to the domestic market. The firm can grow around 50% by increasing its store base in the international markets. Additionally, the recovering U.S. economy, along with e-commerce opportunities, will stimulate growth.

The latest large scale investor to buy shares of TJX was Jean-Marie Eveillard of First Eagle Management. His decision to acquire this stock was perhaps motivated by the firm’s ability to generate healthy cash flows, which has translated to juicy returns on investments for shareholders. Also, great growth prospects and a solid financial position, will allow the firm to consolidate its leading position in the U.S. and continue its international expansion. While currently trading at 20.3 times its trailing earnings, the stock is available at a slight price premium relative to industry peers’ average. However, with an EPS growth rate of 21.5%, a favorable economic situation and an increasing customer base, I believe this stock is worth acquiring.

Can the market hold both?

As the U.S. economy recovers, some analysts fear Ross Stores and TJX will lose customers to full-price retailers. However, the main challenge for Ross is not maintaining its customer base in an improving economy, but expanding its store base without competing heavily with TJ Maxx stores. Since both of these companies are direct competitors, I fear the market is not large enough to hold both, especially since they are growing at a rapid pace. All in all, I feel slightly more optimistic about TJX, particularly due to its international exposure.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned

About the author:

patokehoe
A fundamental analyst at Lone Tree Analytics

Rating: 3.8/5 (5 votes)

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