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Big Profits from Big Discounts

James is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The financial downturn in 2008 was a blessing in disguise for a few very lucky companies.  Families that once shopped exclusively at high end department stores made their way to discount retailers.  Saving money was not only necessary but becoming fashionable.  Discounters experienced a rebirth as consumers clamored for deals.  Fast forward to the end of 2012 and many of these customers have yet to return to their old habits, and discounting is still in vogue.

Over the past few years TJX Companies (NYSE: TJX), Ross Stores (NASDAQ: ROST), and DSW (NYSE: DSW) have been posting huge gains.  But just how long will this trend continue?  Let's take a look at these three discounters in particular and see what the future holds.

TJX operates Marmaxx, HomeGoods, T.K Maxx, Winners, HomeSense, and Marshalls.  The company is known for huge discounting and is very popular among savvy shoppers.

TJX is currently trading at $42.50, which is just below its 52 week high of $46.67 (Figure 1).  The recent pullback seems to be related to initial concerns about potential over-valuation (Sep.) and then the market decline we experienced (late Oct. and Nov.) that hit almost all retailers.

Figure 1:

 

 

At first glance the chart looks impressive, with gains all year long except for the one recent pullback.  But charts often don't tell the whole story.  So before we pull the trigger and add TJX to our long term portfolio let's look at the fundamentals and future projections for this company.

The current P/E of 18.03 suggests that this stock is trading at a premium compared with the industry average of 16.10.  But it could be worth that little extra money.  When we compare five important industry averages (Figure 2), we can see that TJX is a clear out-performer.

Figure 2:

Valuations

TJX Companies Inc

Industry

P/E

18.03

16.10

Sales 5 Year Growth Rate

5.93

-1.41

EPS 5 Year Growth Rate

20.49

-5.98

Net Profit Margin 5 Year

5.50

2.0

RoA 5 Year Average

15.60

3.20

RoI 5 Year Average

33.40

5.30

Looking at the information above, it's easy to see the reason TJX is currently trading at a premium.  But can this continue?

Those that have been paying close attention to TJX's investor relations know that they have quietly been reporting increases in same store comp sales month after month.  Now let's combine that with a serious plan for growth (Figure 3) and we could have a real long term winner for years to come.

Figure 3:

One key element to maintain that vision rests with the CEO.  Carol Meyrowitz has been with TJX for over a decade and has served as the CEO since Jan. 2007.  Over the last six years she has increased shareholder value around 200% while raising dividend payments.  Strong leadership, solid planning, and spectacular returns are just some of the reasons why many consider her a top CEO in the retail game.  With Carol in charge the best days of TJX are still ahead.

While TJX stock trades at a premium, it has great long term potential.  Given current price action I would look for an entry point around $41 or $42.  My 12 month price target on TJX, taking into account growth and a premium on valuation, is $56.  But one year might be too short a time frame, since it looks like Carol Meyrowitz and TJX can stay trendy for years to come.

Ross Stores has recently seen the largest pullback in its stock price in several years.  But these pullbacks are exactly what value investors look for when making long term buys.  Value investors know that when you buy is just as important as when you eventually sell.  After all, price is what you pay, value is what you get.

Ross is currently trading at $53.50, which is about 23% below its 52 week high of $70.82.  Like TJX, the recent pullback seems to be related to initial concerns about potential over-valuation (Sep.) and the market decline we experienced (late Oct. and Nov.) that hit almost all retailers.

The over-valuation problem has now been addressed with this huge drop. We are also learning that the consumer and economy are stronger than the pessimistic outlook that dominated the headlines in October-November.

Looking at a 3 year chart for Ross (Figure 4), we can see that this recent pullback is perhaps the best buying opportunity that we have had in the past 14 months.

Figure 4:

 

Ross is trading in line with industry valuations at a 16.20 P/E, vs an industry P/E of 16.10.  However, Ross is a serious out-performer in many ways and should trade at a premium when taking into account growth, profitability, and financial strength (Figure 5).

Figure 5:

Valuations

Ross Stores

Industry

P/E

16.20

16.10

Sales 5 Year Growth Rate

9.13

-1.41

EPS 5 Year Growth Rate

29.28

-5.98

Net Profit Margin 5 Year

6.10

2.0

RoA 5 Year Average

16.00

3.20

RoI 5 Year Average

33.20

5.30

Looking at the valuations we can see that Ross is a clear winner in this sector.  Management has reaffirmed guidance for the future, which should keep it as an out-performer.  It even appears to post better numbers than TJX.  However, TJX seems to have the more aggressive growth plan and is more diversified with its collection of stores as opposed to a single flagship name.  Look for an entry point around the $50-$52 range for a long term hold with a 52 week target of $66.  However, like TJX I believe that one year targets are a bit short-sighted.

DSW is a discount shoe retailer that operates 364 stores (as of Dec. 2012) in 41 states, as well as an on-line site.  They offer huge discounts on mens and womens footwear in styles that range from dress to athletic.  DSW has recently been on quite the winning streak (Figure 6). With its stock moving up and initiating a dividend, this company can apparently do no wrong.  But let's take a quick look to make sure we're not over-paying for this stock.

 

 

Right away there are a couple red flags.  First, DSW is trading at 22.10 P/E vs an industry average of 20.70.  Though it's trading at a premium, I don't believe it deserves that price.  The most recent quarter (MRQ) had negative EPS vs. one year ago.  The 2.3% dividend that DSW just initiated comes at the expense of a 92% payout ratio.

One positive note is that DSW has practically zero debt and over $300 million in cash.  But that isn't enough for me to label this one a buy.  I would wait to purchase DSW until the MRQ numbers start showing above average positive gains again (for at least two quarters) and the P/E comes back in line with an industry performer.  Right now DSW must remain on my neutral list.

Conclusion:  TJX and Ross are offering great growth, smart management, and a solid business plans that seem to be gaining traction at a time when other retailers are losing their mojo.  Couple that with the recent pullbacks we've seen in the stock price and I believe we have two solid long term buys.  As for DSW, we should wait and see how the future plays out.  I'm looking for a better entry price and stronger MRQ numbers before I can even consider making a long term play.


Lulupoopsalot has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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