Apr 2019: TJX Companies (TJX)

Time is a Friend

I really like the company The TJX Companies (TJX). I understand the business model: they sell discount clothes and home furnishings, often brand-name and designer products that are liquidated/clearance inventory from other retailers. TJX is currently a member of the S&P 500 index. (TJX runs a bunch of stores where I’ve shopped: TJMaxx, HomeGoods, Marshalls. I don’t do all of my shopping at these stores, but if I happen to find something worthwhile, the price is unbeatable. We have shopped at Marshall’s for my son’s toys, socks, shirts … at HomeGoods we found a great bench for our garage, and a stylish-looking full-length mirror.) I evaluate TJX as I would evaluate a long-term business partnership, with the lens of looking at 30 years of their historical financial performance. I don’t try to predict TJX’s stock price, nor do I try to forecast their future financial results. I have no special secret knowledge of TJX. Everything I like about the company is based on information out in the open.

TJX is one of the most consistently improving companies currently in the S&P 500, based on the past 30 years of performance. The first place I look is at the historical diluted earnings-per-share. Diluted EPS takes into account stock options that can be exercised, and that might dilute the shares outstanding in the future. This potential dilution is why I prefer looking at diluted EPS instead of basic EPS. Some companies issue lots of stock options to executives and employees, and so it’s important to account for that dilution when looking at earnings per share.

Figure 1: Diluted Earnings-Per-Share (EPS)

Starting from 1998, TJX is profitable and shows consistent growth over the long-term, particularly through the 2000-2003 recession (maybe a small downward blip but approximately flat) and through the 2007-2009 recession. In 1998, the diluted EPS was $0.11 per share. Ten years later in 2008, the diluted EPS was $0.41 per share (a 3.7x increase in 10 years). Ten years after that in 2018, the diluted EPS was $2.02 per share (a 4.9x increase in 10 years). The vast majority of companies struggled in the 2007-2009 recession. Time is a friend to this wonderful business.

Time is the friend of the wonderful business, the enemy of the mediocre.

Warren Buffett, Berkshire Hathaway Letter to Shareholders, 1989

On the surface, it might appear counter-intuitive that a retail business could perform well through a recession, since retail consumption slows down as incomes (and jobs and investments) go down during recessions. And in looking at the annual earnings of TJX, there is definitely a noticeable slowdown in 2002. Nearly all companies are hurt during recessions, but weak companies show their fragility when the “tide” of economic growth is violently reversed. Although the subsequent results are excellent.

After all, you only find out who is swimming naked when the tide goes out.

Warren Buffett, Berkshire Hathaway Letter to Shareholders, 2001

One of the most important questions for me is: How did the company perform during previous recessions? Did the company lose money during the recession? Was the company profitable during the recession? If profitable, did the company experience profit growth during the recession? How did the company perform in the years following the recession? Did the company growth to new heights in the years following the recession? If a company performs well during recessions (and after the recessions), then that is a strong indicator that the company is protected by an economic moat. Even without knowing specific details of the business, given strong performance through recessions, I believe that an economic moat exists at TJX.

In business, I look for economic castles protected by unbreachable “moats.”

Warren Buffett, Berkshire Hathaway Letter to Shareholders, 1995

There is an important distinction between profitability and profit growth. For a company to remain profitable (any profit at all) through a recession is impressive, as many cyclical companies lose money during downturns. However, profit growth means the amount of profit is increasing every year. Below is the annual earnings of TJX. To the first point, TJX showed profits each year since 1990 (i.e. positive annual earnings). To the second point, TJX had profit growth each year from 1998-2018 with the exception of 2002 (fiscal year ended January). In particular, TJX showed profit growth during the 2007-2009 recession, and grew to new heights in the years afterwards.

Figure 2: Annual Earnings, aka Net Income ($M)

Share Buybacks

TJX has been an aggressive buyer of its own shares for many years. Since 2010, TJX has spent over $1B per year on share repurchases. TJX spent over $1.5B on share repurchases since 2015.

Figure 3: Annual Buybacks ($M)

Annual earnings is the “numerator” in the earnings-per-share (EPS) calculation. The number of shares outstanding is the “denominator” in the earnings-per-share (EPS) calculation. So when you see a management team aggressively purchasing its own shares, it is shrinking the denominator in the EPS, boosting the overall EPS. A prudent management team will decrease (or increase) the number of shares outstanding, depending on the stock valuation and external opportunities available.

I like to look at a company’s buyback trend over time, and also compare with buybacks at other companies. But evaluating buybacks can be a little tricky, because if a company’s annual earnings are increasing, then its financial ability to increase share buybacks should also be increasing. To normalize the buybacks over time, I like to look at the ratio of annual earnings to annual share buybacks. In other words: what percentage of the annual profits does the management team deploy to decrease the share count. If the management team consistently deploys a significant percentage of the profits for share buybacks, this indicates the management team’s confidence in the future of the business (and an opinion of the general price of the shares). A management team that deploys a small percentage of profits on share buybacks might be wary of future of the business, or may believe that the price of the shares are too high. Since 1998 TJX has deployed over 50% of its annual profits on share buybacks every year.

Figure 4: Annual Buybacks as Multiple of Earnings

A management team has many different choices for how to spend annual profits: share buybacks, shareholder dividend, pay down debt, invest in the business operations (e.g. capital equipment, marketing and advertising, headcount growth, research and development), or buying another company. Mediocre companies have large ongoing capital requirements, so that each year’s profits need to be reinvested into the business to keep it afloat. Wonderful businesses are so strong that they don’t require additional investment to continue generating cash. An economic castle is a business that is drowning in cash. The key to managing these types of businesses is to avoid bad capital allocation decisions (i.e. wasting plentiful profits). Without large ongoing capital requirements, good capital allocation decisions include share buybacks and dividends. If the shares are priced attractively, share buybacks are superior to dividends.

We prefer businesses that drown in cash.

Charlie Munger, Berkshire Hathaway Annual Meeting (2008)

Starting in 1999, TJX shares outstanding start to drop, from a high of 2.8B shares to a low in 2018 of 1.3B shares. Over the 19 year period (1998-2018), that represents a shrinkage of 1.5B shares outstanding. Stated differently, TJX shrunk the shares outstanding by 54% over 20 years. From a compound annual growth rate perspective, TJX shrunk the shares outstanding by over 3.7% per year, each year, over a 20 year period. The consistent buyback program at TJX improves the earnings per share for long-term shareholders of TJX.

Figure 5: Shares Outstanding (M)

As the business has fewer shares outstanding, the remaining shareholders have a larger and larger claim on the future earnings of the business. To invert the situation, a prudent management team should increase the shares outstanding (i.e. issue shares, dilute shares) under the following 2 conditions: (a) the stock is overvalued, and (b) the company is receiving in exchange something of significant business value. For example, in the 1970s Teledyne issued public shares in exchange for private business because business conglomerates were selling at a rich valuation premium, while profitable private companies were selling at a valuation discount. (However I believe the stock dilution strategy has many risks in execution, and should be accompanied by an investment thesis. For example Henry Singleton at Teledyne started with the investment thesis of symbiotic-advances in semiconductor manufacturing and control systems because the related fields were both growing enormously at the time. Later Teledyne acquired materials companies in a vertical integration strategy and acquired government sub-contractors to gain the market/pricing power of a primary contractor.) Most management teams seem to destroy shareholder value through excessive dilution.

We have a firm policy about issuing shares of Berkshire, doing so only when we receive as much value as we give. Equal value, however, has not been easy to obtain, since we have always valued our shares highly. So be it: We wish to increase Berkshire’s size only when doing that also increases the wealth of its owners.

Warren Buffett, Berkshire Hathaway Letter to Shareholders, 1992

We will issue common stock only when we receive as much in business value as we give. This rule applies to all forms of issuance – not only mergers or public stock offerings, but stock-for-debt swaps, stock options, and convertible securities as well. We will not sell small portions of your company – and that is what the issuance of shares amounts to – on a basis inconsistent with the value of the entire enterprise.

Warren Buffett, Berkshire Hathaway Owner’s Manual

The below 2 charts show PE ratio and earnings yield, although use approximate figures to illustrate long-term trends. Since 1997, TJX had a PE ratio between 9 and 22, and an approximate earnings yield of at least 4% (PE ratio below 25), during a period of historically low interest rates. Although 4% yields are not good from a long-term historical perspective, low yields are reasonable given other low/negative yielding investment opportunities.

Figure 6: Annual Price-Earnings (PE) Ratio
Figure 7: Rounded Earnings Yield % (except 0.1% as placeholder for errors)

Long-Term Debt as % of Earnings

Many companies finance growth by borrowing long-term debt, so it’s an important final step to verify the financial soundness of the company. One way to check out financial soundness is to measure the ability of the company to pay off long-term debt using annual profits. In other words, how many years of earnings would be required to pay off long-term debt. TJX is financially conservative because it would require approximately 1 year of profit to pay off long-term debt. The equivalent question for an individual might be to ask, how many years of savings (income minus expenses) would be required to pay off a home mortgage?

Figure 8: Long-Term Debt, including Capital Lease Obligations ($M)

TJX long-term debt has a tendency to mildly fluctuate and then step-up. I suspect that is because as TJX develops stronger earning power, the management team feels comfortable adding on more debt. In the past 5 years (since 2014) the company has appeared to be borrow significantly larger amounts. But since both long-term debt and annual earnings have grown significantly, so the debt level manageable. The below chart shows the ratio between long-term debt and annual earnings. One way to interpret this ratio is to ask “how many years of profits would be required to pay off all of the long-term debt?” In the case of TJX, this ratio is currently 0.9 (in other words all of the debt can be paid off with less than one year of earnings). And this ratio has been pretty steady since 1997, showing the management team is prudent about financial leverage.

Figure 9: Long-Term Debt as a Multiple of Annual Earnings

Current Ratio (Short-Term Liquidity)

Another check for financial liquidity is to compare current assets (assets that can be liquidated within 1 year) to current liabilities (liabilities that come due within 1 year). The current ratio is above 1.5, which means the company has a manageable short-term liquidity situation.

Figure 10: Current Ratio (Current Assets / Current Liabilities)

Interest Rates, Valuation, Yield Curve

When evaluating investment opportunities, one of the most important comparisons is the current benchmark interest rate, for example 10-year treasury bonds. An investor has the alternative to put money into “risk-free” treasury bonds. The most commonly traded term is usually the 10-year US Treasury Bond, currently yielding 2.48%. The US Treasury Bond is considered a “risk-free” investment, because the US Government can raise funds through many sources such as taxation. Ideally, the investment under consideration yields at least twice the 10-year US Treasury Bond, to provide a “margin of safety” (as described by Benjamin Graham).

Figure 11: US Treasury Yields as of April 2019
(https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield)

According to Yahoo Finance (screenshot below), TJX’s PE Ratio (TTM) as of Apr 11, 2019 is 22.29, which taking the reciprocal, implies an earnings yield of 4.49%. TJX’s 4.49% earnings yield is not quite twice the 10-year US Treasury yield of 2.48%, but still offers some margin of safety on yield.

Figure 12: TJX Quote on Yahoo Finance

When considering the trade-off between a great price and a great business, I am reminded of Charlie Munger’s most important contribution to Berkshire Hathaway:

From my perspective, though, Charlie’s most important architectural feat was the design of today’s Berkshire. The blueprint he gave me was simple: Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.

Warren Buffett, Berkshire Hathaway Letter to Shareholders, 2014

In other words, given a choice between a wonderful business and a wonderful price, better to choose the wonderful business (at a fair price). In my opinion TJX is a wonderful business at a fair price (not great price).

Yield Curves are important because they reveal the current stage in the short-term economic cycle (aka short-term credit cycle). I will save a detailed discussion of yield curves for a future weekly article. In last month’s article, I provided a few resources about the yield curve. Below is a long-term chart of the difference between the yield in 30-year treasury yields and 3-month treasury yields. Comparing our current yield curve to prior cycles, I would guess that we have a few years left before a recession. In the chart below, I am looking for the timing when the 30Y-3M crosses 0.0 on a downward slope … the most recent time happened in 2006-2007 shortly before the prior recession … the previous recession of 2000-2001 was preceded by the 30Y-3M crossing 0.0 on a downward slope in 2000. The current reading for 30Y-3M is 0.47 (not quite 0.0 yet). Without going into lots of detail, an upward sloping (i.e. positive yield curve) is required for credit-creation because banking-type entities borrow short-term and lend long-term … once the yield curve goes negative, the traditional banks slow down lending dramatically, and any non-bank entities that continue lending will reach into lower-quality credits to maintain a spread … at that point, it’s just a matter of time before the short-term credit cycle ends. We’ll keep an eye on this indicator. I have some ideas of strategies when it crosses 0.0 on a downward slope (those ideas I will save for the weekly articles).

Figure 13: Yield Curve: 30Y-3Month,
(Source: https://stockcharts.com)

Conclusion

TJX Companies (TJX) s one of my favorite companies in the S&P 500. TJX is the second company I have chosen for a monthly article on this new blog. TJX has shown consistent growth over the past 30 years, with a strong history of share buybacks, amidst reasonable valuations, conservative liquidity management, and modest use of debt. TJX’s current valuation is relatively attractive relative to benchmark interest rates, and there is still 1-2 years remaining in the short-term economic cycle. For long-term-focused investors, TJX is worthy of further study.

Disclosure: I own shares in TJX Companies (TJX) as of publishing this article (April 2019). I have no intention of selling my position in the near future. This article is not a recommendation. Investors should make their own determination of whether or not to buy or sell this stock based upon their specific investment goals, and in consultation with their financial advisor.