Can You Maxx Out Profits with this Stock?

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

I'm always frustrated when I find a company that I really like their stores, yet management doesn't seem to appreciate them as much as the customers do. The business I'm referring to is TJX Companies (NYSE: TJX). This isn't a case where management doesn't know how to run the company (although I wish they would expand the firm just a bit faster to reward investors with a better growth rate).

But if management isn't going to grow the business any faster, then investors should be asking why TJX Companies is paying such a small dividend. I've usually heard pretty consistent praise for each of its divisions, and the most recent earnings were decent, but it still looks like better opportunities exist. 

TJX Companies operates the TJ Maxx, Marshalls, HomeGoods, and Winners chains. Most people know this company by their two primary brands, which makes sense as TJ Maxx has nearly 1,000 domestic stores and over 300 internationally. The Marshalls chain has nearly 900 domestic stores, but just 12 internationally. HomeGoods seems to be the company's up-and-coming concept with less than 400 domestic stores and over 100 stores operating under the HomeSence name in international markets.

TJX Companies’ competitors include Ross Stores (NASDAQ: ROST), Kohl's (NYSE: KSS), Target (NYSE: TGT), and many others. While these rivals don't all offer the same type of closeout merchandise that, say, a TJ Maxx or Marshalls do, they all offer competitive values for shoppers. Let's take a look at how TJX Companies performed in its most recent quarter.

Considering overall sales were up 9%, comparable sales increased 7%, and EPS grew 24%, one might wonder how I would be frustrated with these results. I think it's an aberration compared to what analysts expect in the future. With sales up 9%, the chances of EPS increasing better than 20% going forward are fairly low. In fact, I would suggest investors can learn much more about the potential growth of TJX Companies based on the number of stores they opened.

The division that grew the most was TJ Maxx, with 18 new stores added to the existing 1,300. If the company keeps up its current rate of opening new locations, which is generally what's expected, the annualized growth rate in new stores would be less than 6%. Even if the company is able to keep comparable sales in the mid to high single digits, this still won't give enough growth to drive earnings per share at the level the stock is priced at.

The company did better with its HomeGoods unit by adding 11 stores to the current total of about 500. This rate of growth would indicate new stores coming at about 9% per year. Combined with strong comparable sales growth, this would give investors the type of return they're looking for. In addition, the company's financials are strong, but I have to wonder: where is TJX Companies free cash flow going?

The TJX Companies generated adjusted operating cash flow of over $1 billion, which was up almost 28% from last year. While this is certainly impressive, the company spent about $535 million repurchasing shares, and used roughly $155 million to pay dividends in the first six months of the year. During the same timeframe, the company beat earnings estimates by about 2% each quarter, and the numbers work out to a free cash flow payout ratio of only 16%.

The company is generating significant free cash flow, and in just the last six months it had at least $300 million that was neither used for share repurchases nor dividend payments. With this additional $300 million, the company could have either increased its new store openings, or increased its dividend. Since The TJX Companies decided to do neither, the company expects to essentially match what analysts anticipate for this calendar year. If the company continues to match what analysts predict, longer-term growth will come at just north of 12%. This is really the crux of why I believe there are other opportunities investors should consider instead.

Among TJX Companies’ competition, each company offers investors a different dynamic. Investors looking for slightly higher earnings growth could consider Ross Stores, which is expected to not only increase its earnings per share faster, but also has stronger organic revenue growth than TJX Companies.

While Kohl's has recently run into challenges, the stock appears to have priced in these issues at just 11.4 times current year earnings. The company also offers an attractive dividend yield at better than 2.4%, and it has the highest gross margin among all of the retailers we've examined.

This leads us to Target, which I believe is a more attractive investment opportunity than TJX Companies. Target has a yield that is more than double that of TJX Companies, and is expected to grow at about the same amount. The diversity of selection at Target also offers investors a hedge against any future economic issues as they have expanded their grocery selection tremendously. Customers might put off shopping for clothing and housewares in a downturn, but they have to eat.

While TJX Companies could be a good investment, at nearly 18 times forward earnings, investors may be expecting too much. With neither the commitment to strong earnings growth or a higher dividend, it just looks like other opportunities are more attractive.

MHenage 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.If you have questions about this post or the Fool’s blog network, click here for information.

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