Friday, August 18, 2006

Kohl's and TJX: Money in the Middle

News Analysis
August 18, 2006

Business Week Online

Kohl's and TJX: Money in the Middle

The two chains, which sell apparel and other items to middle-income consumers, hit 52-week highs while larger retailers disappoint the Street

Move over, Wal-Mart (WMT ). With slowing consumer spending beginning to crimp quarterly results for large retailers, some investors have been thinking outside the usual big boxes (see, 8/16/06, "Wal-Mart, Home Depot Hit Potholes"). Shares of both Kohl's (KSS ) and TJX (TJX ) recently touched 52-week highs, though it's uncertain how long either can avoid their peers' troubles.

Menomonee Falls (Wisc.)-based Kohl's operates about 750 stores in 43 states, up from 670 at the midpoint of 2005. Headquartered in Framingham, Mass., TJX runs such chains as T.J. Maxx, Marshalls, HomeGoods, Bob's Stores, and A.J. Wright. The two retailers have thrived selling apparel and accessories to middle-income shoppers, rather than those at either extreme of the income spectrum.

Midrange consumers are still opening up their pocketbooks, analysts say. "Strength has been seen across the moderate apparel space," notes Goldman Sachs analyst Adrianne Shapira in an Aug. 11 note. However, this spending may not last. Shapira has a neutral recommendation on Kohl's, citing "macro and competitive headwinds." (Goldman has an investment banking relationship with Kohl's and is a specialist in the company's securities.)

Solid sales have helped buoy the retailers' stock prices. Through afternoon trading on Aug. 17, Kohl's rose 27.4% for the year, while TJX was up 17%, adjusted for dividends. Fellow middle-market retailer J.C. Penney (JCP ) gained 24.6% (see, 7/13/06, "J.C. Penney's Stock: Wearing Well"). By comparison, the Standard & Poor's Retail Index lost 2.3% over the same period.

EARNINGS JUMP.  On Aug. 10, Kohl's reported a 24% jump in its second-quarter profit. The stock price moved steadily higher in subsequent days, climbing to a 52-week high of $62.45 during trading on Aug. 17 before pulling back and closing at $62. "We continue to see consistency in all lines of business and all regions of the country," said Larry Montgomery, Kohl's chairman and chief executive officer, in an Aug. 10 statement.

Bear Stearns, which has an outperform recommendation on the stock, projects Kohl's to open 200 stores in 2006 and 2007. In addition, a $2 billion share repurchase program announced in March stands to boost Kohl's earnings per share and absorb extra stock created when employees exercise stock options.

TJX turned in similar results less than a week later. On Aug. 15, the company posted a 25% increase in second-quarter earnings. Its shares touched a 52-week high of $27.23 on Aug. 17 before fading to $26.97.

"While pleased with our overall performance, we continue to address areas of our business in which we can improve," Ben Cammarata, chairman and acting chief executive officer of TJX, said in an Aug. 15 statement. (Company spokespeople for Kohl's and TJX did not return phone calls prior to deadline.)

TJX's second-quarter earnings showed no signs of consumer weakness, observes Credit Suisse analyst Paul Lejuez, who rates the stock outperform. "We believe management has positioned the company to continue to achieve upside to earnings over the next several quarters," Lejuez says in an Aug. 15 report. (Credit Suisse has an investment banking relationship with TJX.)

RETAIL STANDOUTS.  Both retailers have put the heat on their rivals with competitive pricing and low overhead, analysts say. Morningstar analyst Kimberly Picciola says of Kohl's in a June 15 report: "Although this discount department store chain competes in a crowded field, its big-box, off-mall concept is less costly to operate than many of its rivals, which results in healthy operating margins and solid returns on invested capital." However, Picciola rates the stock two stars out of five, estimating its fair value at $53.

Meanwhile, TJX has made strides recently to improve its cost structure. Some executives have taken salary cuts, and the company has also lowered its headcount. "We are encouraged by recent cost-cutting initiatives," says UBS analyst Meredith Love Kent, who has a neutral recommendation on the stock, in an Aug. 11 note. (UBS makes a market in TJX securities.)

Others have also cheered the retailers' merchandising programs. On Aug. 11, S&P raised its fiscal 2007 earnings estimates for Kohl's. S&P analyst Jason Asaeda lauded the company's "investments in more exclusive, higher-quality brands and products" (see, 12/20/05, "Kohl's Is Worth Trying On"). On Aug. 15, Asaeda also raised his earnings projections for TJX, noting that its T.J. Maxx and Marshalls chains posted a 6% same-store sales increase in the challenging women's sportswear category.

GROWTH PLATEAU?  Nevertheless, a slowing economy could affect these retailers eventually (see, 7/18/06, "Target: The Canary in the Economy?"). "We do not believe that there are enough short-term catalysts in the face of a slowing economy to generate significant upside," says Merrill Lynch analyst Stacy Turnof in an Aug. 10 report on Kohl's. Turnof's recommendation on the stock is neutral. (Merrill has an investment banking relationship with Kohl's, owns more than 1% of the company's stock, and makes a market in its securities.)

Another set of complex challenges greets TJX. "As its more mature concepts reach the maximum number of stores, TJX will have to increasingly rely on its newer chains to grow, and so far results have been disappointing," notes Morningstar's Picciola, who rates the stock three stars out of five. The company's A.J. Wright chain continues to lag.

Kohl's and TJX have been looking sharp in recent months. Still, they'll have to strike some impressive poses to stay in vogue if their customers tighten their purse strings.

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