Still Plenty of Growth Prospects With the Off-Price Retailers

If the markets needed any more proof that off-price retailers are likely to outperform the market, then they surely got it with the latest results from TJX (NYSE: TJX)and Ross Stores (NASDAQ: ROST). Both companies beat their internal guidance in terms of sales and earnings, and demonstrated that they have plenty of growth potential in the years ahead. Despite their strong share-price performance over the last year or so, it's not too late to buy into the story.

Both companies generated some pretty impressive comparable-same-store sales growth in the second quarter, and it's noticeable how correlated their sales growth has been over the last few years. In addition, note that they are both lapping some strong growth numbers from last year.

source: company accounts

In addition, they both raised same-store sales guidance for the year.

Following better-than-expected same-store sales growth of 4%, TJX raised its full- year comparable-same-store sales estimate to 2%-3% growth from its previous range of 1% to 2%.

In addition, its new EPS-range forecast of $2.74 to $2.80 represents adjusted underlying growth of 11% to 13% over last year. Furthermore, the commentary around the results suggests that it is achieving its objectives for 2013. There are four key areas that investors need to focus on in this context.

Firstly, TJX's European expansion plans are working well, with 6% comparable same-store sales growth recorded in the quarter. European segment margins also increased to 5.2% from 3.5% last year, and given that TJX's Marmaxx (T.J. Maxx and Marshalls stores) currently generates margins of nearly 16%, it's not unreasonable to believe that TJX can increase European profitability in the near future. Europe presents a significant growth opportunity.

Second, its home-goods segment grew profits by over 34% in the quarter, and given the resurgence in the U.S. housing market, TJX can expect more to come in the future. Home goods now contribute 9.4% of segment profits from a figure of 8% last year.

Third, one of its objectives is to widen its appeal beyond its traditional customer base by marketing itself more to younger consumers. Indeed, on its conference call, it declared that the plans were working.

Our increase in customers is coming from a younger group of customers" and "we're absolutely bringing in younger customers. That's where our increase is coming from.

The final objective is the second-half launch of an e-commerce-enabled T.J. Maxx website. Plans for the site were described as being 'on-track,' and since retail companies like VF Corp are generating good growth from e-commerce expansion, the future looks bright for this initiative.

While the first chart indicates that its fortunes are very similar to TJX, there are some differences. Ross isn't chasing e-commerce growth or making aggressive international expansion plans, but it has managed to generate some impressive traffic growth over the last few years. In addition, its focus on improving execution has lead to its profit margin rising to 8.4% from 7.7% last year, and this compares favorably to TJX's overall profit margin of 7.4%.

However, the one area where Ross under-performed TJX was in its home-goods sales, which only rose inline with its total sales growth. Similar to its rival, Ross Stores continues to beat its own guidance.

source: company presentations

Essentially, both companies are executing well in their core U.S. off-price clothing markets. While other retailers are suffering from the ongoing cautiousness of the consumer, the off-price concept seems tailor-made for consumers seeking opportunities to avoid paying full price.

In addition, running an off-price retailer requires a significant amount of experience in purchasing inventory and merchandising. Arguably, this provides TJX and Ross with some significant barriers to entry that aren't replicated across many other parts of retail.

It's been a difficult year for the retail sector with consumers being challenged by payroll tax increases, sequestration fears, tax-refund delays and some unusual weather conditions. However, both companies have demonstrated that they can outperform in a difficult retail environment, and with the U.S. economy continuing to generate moderate GDP growth of 2% to 3%, the off-price retailers have longer to run.

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Lee Samaha has positions in TJX and Ross Stores. 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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