TJX – the Magician, the Vulture

Normally I write about books I’m reading (to keep myself accountable for my NYE resolution of reading more), but two weeks ago I had a minor procedure and in a drug induced haze decided to write about one of my favorite companies…TJX.

What’s in your PA (personal account)?…finance nerds ask each other. Edgy people answer with crypto. Millennials answer with FAANG. Financial engineers answer with a position on VIX. Geniuses answer with “Vanguard? Is that a stock? That’s what I have.”

Me? Allow me to explain to you, in just two parts, why TJX’s business strategy makes it my favorite stock in my personal portfolio (I have Vanguard indices in there as well, don’t you worry). It is also one of my favorite places in real life, which will surprise nobody. This is what happens in your 30s!

The Magic Trick: TJX has managed to sell luxury goods “off price” without compromising brand value by perpetuating scarcity – a key attribute of luxury.

People are generally aware of TJX’s strategy and status as an “off price retailer”. Their buying strategy relies on sourcing from manufacturers through closeout sales, manufacturing errors, order cancellations, and vendors with extra product. They get limited runs of product and send them to the most appropriate stores. This scarcity of product leads to the much celebrated “treasure hunt” experience that is a cornerstone of the TJX strategy.

In all the conversations I’ve had with investors (mostly male), there is a misconception that TJX is a bargain bin type of experience. Musty… used, even. I’ve realized that they’ve likely never stepped foot inside one of TJX’s properties. They’re not bargain bins – the locations are well appointed, crisp, modular, and the merchandise is generally of reliable quality, frequently premium, and sometimes, if you’re looking carefully, luxury.

I’ll differentiate here between quality and luxury. Quality isn’t necessarily luxury – Costco’s Kirkland brand comes to mind.

Luxury, on the other hand, is not luxury if it is readily available at an accessible price point. Two criteria of a luxury product is that it is 1) available in purposefully restricted and controlled distribution and 2) that it is offered at a price that far exceeds what its mere functional value would demand (this is not the comprehensive criteria, just two attributes).

I’ve seen Chopard, Balmain, Laboutin, Pucci, Cavalli at TJX. Why are luxury brands comfortable with selling to TJX?

TJX protects the “luxury” nature of these brands by perpetuating their scarcity. Even though there’s a price cut, somehow the “treasure hunt” aspect of TJX’s business model makes up for it. There’s only so much product available, and by virtue of TJX’s business model, everybody knows it.

TJX’s online presence is interesting. They have goods available. However, you can’t shop by brand – that is, filter for certain brands – and this is intentional, in order to protect brand power. Luxury brands don’t want their merchandise listed 20-60% off and easily discoverable online. If you find Chopard, it’ll be happenstance, not by design.

As an investment, TJX is a clever way of getting exposure to a diversified basket of quality and luxury retail.

TJX the Vulture: Feasting on the long, slow death of the department store.

As mentioned earlier, their buying strategy relies on sourcing from manufacturers through closeout sales, manufacturing errors, order cancellations, and vendors with extra product.

But what their strategy really relies on is the long, slow death of the department store.

That is, the department store model. TJX’s buying strategy is a derivative of 1) the decline of traditional distribution networks for retail and 2) the fashion bubble. These two components are related.

Most people are aware of the decline of the department store. Even pre-pandemic, malls of a certain class have been in decline. Anchor tenants were fading away. Partly ecommerce, partly due to broader secular trends about leisure time.

But what I personally was less aware of, or perhaps just couldn’t articulate, was the fashion bubble.

This outstanding article dives into that fashion bubble, but the long and short of it is this – the seasonal “collection” model and distribution doesn’t make any sense and hasn’t for a long time.

Manufacturers and designers have been on an accelerating production line of collections and shows, and department stores have been desperate to push that product to try and revive their top lines – and then they’re desperate to get rid of product when it doesn’t fly off the shelves, so they start marking it down in order to make room for the next round of product which will, of course, outperform the previous run of product… yikes.

In particular, Return to Vendor policies are nuts. An excerpt from the article:

R.T.V. stands for “return to vendor,” which is what it sounds like: If a collection — the one that the store has asked you to pad out with novelty and exclusives — doesn’t sell, the retailer can return it and ask for its money back. According to Nutter, as stores struggled, the terms of this deal got worse. In some cases, stores asked designers to sell on consignment or to share costs if a certain percentage of the collection didn’t sell at full price. So let’s say a store decided to mark the collection down early: You now owed it for those losses...

…In order to protect exclusivity, stores had to commit to even larger buys, ordering more clothes than they could possibly sell. Then, when they couldn’t move the stuff, they’d return it. Thanks to the rise of fast fashion and the luxury market’s simultaneous attempt to keep up with its impossible pace, it all started to feel disposable. So detrimental was the cycle of overproduction and discounting to luxury goods that in 2018, Burberry, the British label, revealed that it had been burning — not metaphorically but literally: burning — $37 million of worth of merchandise per year to maintain “brand value.”

The timing of it, the way the inventory is managed – none of it makes sense anymore, particularly in the dawn of a D2C world. With the pandemic, the bubble appears to have popped. There are mountains of inventory sitting in warehouses around the world that are going to have to get offloaded, pushed a year, or literally destroyed. This makes it a feast for TJX. There’s likely plenty of high quality stuff that was intended for department stores and will now wait to be rescued.

In the long term, as traditional retailers and department stores go out of business, TJX will have somewhat less department store bloat to consume. But as Sears has shown us, it’s a very, very long tail to feed on (I previously had a white-haired coworker who said that Sears had been going out of business since he began his career).

But there’s another flavor of bloat for TJX to potentially feed on: the rise of ecommerce is creating a glut of returned product.

Ecommerce brands are not handling returns well. It’s not really a place with a home in terms of a department: customer service handles it at the front end, then it’s an operations problem, but those responsible for the top line generally don’t care and integrate returns data into their work – they’re generally tracking net, not gross sales post returns.

So – there’s more retail bloat out there for TJX to consume, but I can’t figure out with certainty whether or not TJX purchases returned product. My searches have not yielded a lot of answers. My hunch is that they do, but don’t talk about it publicly…

Returned product gets triaged. The good stuff gets returned to shelves and sold at original pricing (or, possibly, sold to TJX?) . The other stuff goes to an ecosystem of second-hand buyers. And some stuff goes, unfortunately, as mentioned by the article above, literally gets burned to ashes.

In conclusion, and just for fun, here’s performance of TJX vs. the SPY vs. a luxury ETF vs. a retail ETF:

TJX is in white.

SPY is in green.

Luxury ETF is red.

Retail ETF is purple.

Interestingly, TJX has performed closer to the luxury ETF than to broader retail. If you’d like to dig in to constituents of these ETFs, here are the top 10 for each: