What Is the Winning Formula for These Off-Price Retailers?

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Source: The TJX Companies

According to research by eMarketer, the two largest off-price retailers in the U.S., The TJX Companies and Ross Stores , have been among the fastest growers in the retail industry as they have opened close to a combined net total of 800 new stores since 2008. Both of them have plans to open another 200 stores combined this year and this starkly contrasts with the plans of department store operators, which have been downsizing. What is the winning formula for the off-price retailers that have managed to buck the trend? Also, as more consumers appreciate the value of frugality, which of the listed off-price retailers, TJX, Ross Stores, or Burlington Stores , is the best investment for capitalizing on the off-price segment's growth?

Sourcing and inventory management
As the world's largest off-price retailer TJX boasts tremendous advantages in economies of scale, particularly in the area of sourcing. It sources its products from 16,000 vendors in more than 60 countries and it is supported by a 800-strong buying team. With its top 25 suppliers accounting for only a quarter of its purchases, TJX has great bargaining power with its suppliers.

In comparison, TJX's biggest competitor Ross Stores has a smaller 660-strong buying team and a less diverse network of 7,900 merchandise vendors. As a result, TJX has a 50 basis-point advantage over Ross Stores on gross margin.

TJX's excellent inventory management gives it another key competitive advantage. Instead of using 'one-size-fits-all' inventory management systems, TJX has developed its own internal inventory systems which it has customized to its needs. This has enabled TJX to make the most appropriate inventory replenishment, pricing, and markdown choices and adapt its individual store merchandise assortments to match local tastes.

The results speak for themselves. TJX has the best inventory turnover of its off-price peers at 6.6 times, while Ross Stores and Burlington have inventory turnover ratios of 6.0 times and 3.9 times, respectively.

A more focused domestic company
It is interesting to note while TJX has a higher gross margin than Ross Stores, its operating margin (12.2%) is slightly inferior to that of Ross Stores (13.1%). This is likely because Ross Stores enjoys cost advantages as a more-focused domestic company with only two brands: Ross Dress for Less and dd's DISCOUNTS.

In contrast, TJX has operations in Canada and Europe and a host of brands such as T.J. Maxx, Marshalls, HomeGoods, Sierra Trading Post, Winners, HomeSense, and T.K. Maxx. As consumers identify with brands instead of companies, TJX has to spend significantly more money and effort to promote its individual brands in different countries.

However, this slight disadvantage in advertising spend is more than compensated for by TJX's international growth opportunities. While Ross Stores is limited to growing its presence in the U.S., TJX has the advantage of expanding both domestically and abroad. In particular, TJX's Europe off-price business T.K. Maxx is the pioneer of the off-price retailing concept in the U.K. and Ireland, and it remains the only major off-price retailer of apparel and home fashions in Europe. TJX sees the potential of eventually doubling its European store count to 875 over the long-term.

Source: Burlington

The biggest stores
While Burlington is smaller than TJX and Ross Stores in terms of revenues, it has leveraged on its size in a different way. On average, its stores are significantly larger than those of its off-price peers at between 50,000 and 80,000 square feet each. In contrast, TJX and Ross Stores typically have stores in the 29,000 square-feet range.

Burlington's bigger stores give it two key advantages over its competitors. Firstly, Burlington can offer a wider product range which accentuates the 'treasure-hunt' shopping experience. Secondly, it has a better chance of getting more favorable locations and rents as the anchor tenant in certain locations because it can take on larger retail spaces. For example, Burlington gained the anchor tenant position at the Shoppes at St. Lucie West in October 2013 with a 65,000-square-foot store.  

However, low prices remain the key attraction for customers of off-price retailers, and this makes sourcing their most important competitive advantage. With revenue approximately one-sixth  of that of TJX and a smaller supply chain network of about 4,000 vendors, Burlington doesn't have the scale economies of its larger peers.

Foolish final thoughts
The proof of the pudding is in the eating. TJX has the most consistent financial track record of its peers. Fiscal 2014 marks the 15th consecutive year of comparable-store sales growth and the 18th year running that TJX has raised its dividend. In addition, TJX's unrivaled scale in purchasing, industry-leading inventory turnover metrics, and international growth opportunities make it the best off-price retailer investment.

2 stocks changing the retail world
Some retailers are changing the world, but they aren't your usual suspects. Off-price retailer TJX is one of them. To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.

The article What Is the Winning Formula for These Off-Price Retailers? originally appeared on Fool.com.

Mark Lin has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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