Off-price retailers, such as TJ Maxx, Ross Stores, and Burlington Stores, have been defying norms in the retail industry. While the rest of the market takes one path, these companies choose to zig instead of zag. Their unconventional approach to profit has caught the attention of investors and analysts like Aneesha Sherman from Bernstein.
At first glance, the off-price model may not seem like a home run. Average prices hover around $15, gross margins are below 30%, and marketing expenses are almost nonexistent. However, despite these seemingly unfavorable conditions, off-price retailers have been gaining market share consistently over the years. Even during the pandemic with limited online presence and forced store closures, these retailers have managed to attract customers with their discount offerings.
TJX, in particular, has emerged as a standout performer. Since we highlighted the company this spring, its shares have risen by 9%, outpacing its peers tracked by the SPDR S&P Retail exchange-traded fund (XRT).
Sherman’s analysis of the off-price retail sector has shed light on several key factors contributing to their success. These factors have reinforced the belief that off-price retailers have carved out a distinct position in the market.
One of the critical elements is cost savings. Off-price retailers enjoy lower costs compared to traditional retailers across multiple areas such as distribution, freight, import costs, depreciation & amortization, advertising, and general & administrative expenses. This ability to keep costs under control helps offset higher product costs.
Moreover, off-price retailers prioritize low prices and make trade-offs that foster customer loyalty. They may accept slightly higher product costs as a percentage of sales in exchange for offering competitive prices to their customers.
In conclusion, off-price retailers have proven their resilience and ability to thrive in a challenging retail landscape. Their unique playbook sets them apart from their peers, attracting shoppers who appreciate the value and affordability they provide.
The Value Proposition of Off-Price Retailers
The off-price retail sector has long been underestimated by critics who fail to recognize the unique advantages it offers. While closeout buys certainly lead to attractive profit margins, off-price retailers remain committed to their core value proposition: passing on the majority of the benefits to the consumer.
Costco Wholesale, for instance, has steadfastly maintained this approach, even if it means sacrificing margins. And yet, this commitment has proven to be a wise investment in the long run, as it attracts and retains a loyal customer base.
One of the concerns raised by skeptics is the absence of an e-commerce presence for these retailers, especially in light of the pandemic-induced shutdowns. However, this perceived weakness has actually turned into a hidden strength, particularly due to the soaring transport costs associated with shipping products directly to consumers’ homes.
Unlike their peers in the retail industry, off-price retailers continue to enjoy significantly lower distribution costs thanks to their bricks-and-mortar model and the absence of last-mile delivery expenses. While most omnichannel retailers allocate high single-digit percentages of their sales to distribution costs, and e-commerce-heavy brands incur double-digit expenses, off-price retailers keep their distribution costs as low as 5% of sales.
Furthermore, there are additional factors that contribute to the success of off-price retailers. Their lean operational model consistently generates cash flow and profitability, making it a difficult model to replicate. This inherent attractiveness sets them apart from their competitors.
Given these advantages, industry expert Sherman believes that the off-price sector is well-positioned to outperform both in the short and long term. As macro conditions improve for lower-income consumers, we can expect them to trade down from mainstream brands and continue to embrace off-price offerings. Additionally, off-price retailers are steadily gaining market share from traditional brands and department stores.
Based on these optimistic projections, Sherman maintains outperform ratings for TJX, Ross, and Burlington stocks. The respective price targets for these stocks are $90, $133, and $200.
In conclusion, the off-price retail sector demonstrates a unique value proposition that has helped it navigate the challenges facing the industry. Its focus on delivering savings to customers, lower distribution costs, and a profitable and replicable operational model make it a compelling choice for both short-term and long-term investors.