Retail Therapy Means Higher Margins

Retail therapy (shopping to you and me), so the sociologists tell us, is a means by which urban men and women seek to lift their spirits by comfort purchases of inessential goods. This is in contrast to compulsive and repeated binge shopping of largely luxury goods (normally funded by means of maxed-out credit cards) which researchers at the University of Melbourne have classed as a psychological disorder called oniomania[i].

Now you know what that vice is called.

Despite that rather censorious phrase – comfort purchases of inessential goods – selling lifestyle goods is a good place for retailers to be right now. In fact, fun shopping is more profitable than sad shopping because inessentials carry much higher margins than essentials.

Now one man’s (or woman’s) essential is another man’s inessential. What you are used to, and what you experience, directly and vicariously, colours your expectations. If you have been brought up in an affluent late-industrial society, the chances are that you will have more demanding aspirations than your troglodytic ancestors. (And I have absolutely nothing against troglodytes).

As far the comfort angle, I say: all purchases should be comfort purchases. I certainly don’t see any virtue at all in discomfort purchases. I’m not saying we should get daily highs from shopping; but every trip to the supermarket, as much as to a DIY store, should be a pleasant experience.

Yet until relatively recently shopping was more of a chore than a pleasure. Who would want to go back to the days of the cult sitcom Are You Being Served (comic as it was)? These days, big retailers offer more choice, better value and a more intelligent shopping experience. Much of this has been facilitated, of course, by highly sophisticated IT systems, which the customer hardly sees.

How then, after so much intelligent progress has something gone wrong for many big retailers who have been so successful for so long – both in the UK and the USA? The big four UK supermarkets are struggling to maintain profits, despite a growing economy. Even mighty Walmart has been stalling.

There is now a parting of the ways between the mainly food-oriented retailers who have focussed on what they think are essential goods and the mostly home and apparel-oriented retail therapists who believe that the only essential is that shopping should be enjoyable.

And people (I hate the word consumers, which reduces us all to automata), especially younger people, want to be surprised. They want to sample, try and experience new things every time they shop. That means that store layouts and product lines must be in constant flux.

I foresee that the retail therapists, who operate at the right price-quality point and who have leveraged the capacity to surprise and delight, are going to surge in the late twenty-teens as the behemoths tumble.

Which retailers do I like? In July, I praised Associated British Foods (LON:ABF), which owns and operates Primark, for its extraordinary ability to offer value apparel at knock-down prices (and make money too). ABF’s shares have done nicely of late.

But value – quality for money – is just part of the story. Note that, at the other end of the price spectrum, SuperGroup (LON:SGP) whose products do not come cheap, has powered ahead on the back of brilliant branded design which affluent young people are prepared to pay for. Just being cheap has never been a viable business strategy.

You don’t have to be Mary Queen of Shops to know that the secret formula of successful retailing is something around the combination of price, quality, branding, design and presentation. And it rests on canny purchasing, slick marketing, efficient logistics and state-of-the-art IT. You will know it when you see it.

So let’s take a look at a retailer which uses strategically located stores to sell mostly branded apparel and household goods at discounted prices. This retailer has a knack of selling affordable items that people never even knew they needed in huge volumes by constantly surprising and delighting its loyal customer base. This company understands comfort purchasing like no one else.

In the UK you will know them as TK MAXX, which has been here for 20 years or so now. In the USA, they are best known as TJ MAXX, Marshall’s and HomeGoods. The mother company of all of these chains trades as The TJX Companies, Inc. (NYSE:TJX), a group which describes itself as the largest off-price department store chain in the United States.

This group operates seven retail brands in six countries, employing nearly 200,000 staff. There are four business divisions: Marmaxx and HomeGoods in the US as well as TJX Canada and TJX Europe.

Enter a TK MAXX in the UK and your first impression is one of a light, airy space stocked with merchandise of all shapes and sizes. Cosmetics, shoes, handbags, clothing and accessories are displayed alongside home furnishings – soft (cushions) and hard (chairs, coffee tables) – tableware and kitchenware; all without clutter. All goods bear two prices – the recommended retail price and the price for which the product is actually for sale – often as little as a third of the first. Of course this is good marketing; but it works – customers believe they’ve secured a bargain.

The concept is to create a sense of an entire shopping mall in a single store. Aficionados talk of a treasure hunt experience. Think of a busy Arab souk, but air-conditioned. In the US and globally, the average store size is 23,000 feet (2,137 square metres), usually over two levels. That makes for a space which is roughly 33 metres square, meaning that you can saunter from one end of the store to the other in about 24 seconds[ii]. Compare that with the trek required to find the eggs in a standard big surface British supermarket.

Across its 3,250 or so stores TJX emphasises its flexible business model. Their global purchasing operation – 900 people in 13 offices across 10 countries – is able to react swiftly to changing consumer and pricing trends. The group sources merchandise from over 16,000 suppliers in 60 countries worldwide, offering constant feedback to suppliers on customer preferences.

Their core demographic is shoppers with household income from US$50,000 to US$1 million with a younger, more trend conscious age profile (and I suspect a female bias).

Such people are constantly digitally connected and all successful retailers these days have had to carefully reassess the balance of resources allocated between their bricks-and-mortar stores and their online offer. In TJX’s case, three online trading platforms replicate the group’s store offer in cyberspace. In the UK there is tkmaxx.com, which is a good simulacrum of the physical store, though nowhere near as enjoyable.

On 18 August the company issued an update for the second quarter of the current fiscal year ended 01 August 2015. Net sales increased 6% to $7.4 billion and consolidated like-for-like store sales increased by 6% as compared to 3% last year. Net income was $549 million and diluted EPS was $.80, a 7% increase over the previous year’s adjusted $.75, exceeding both management and analysts’ expectations.

For the first half of the current fiscal year, net sales were $14.2 billion, a 6% increase over last year. With footfall still increasing the outlook for the autumn and Christmas shopping seasons looks excellent. This world class retailer will turn over nearly $30 billion of sales this year, but the company’s ambition is already to be a $40 billion-plus retailer!

The group’s balance sheet is robust. Huge retailers with massive buying power can finance a substantial portion of their balance sheet at very low cost from zero interest trade payables.

Overall, the group’s total square footage grew by 5% last year with 169 new stores reaching a total of 3,219 stores worldwide. The long-term (five year) plan is to have 5,150 stores worldwide: that’s a 60% increase on the current level. You certainly can’t accuse the management team of thinking small is beautiful.

If TJX is already big in the USA, Canada, the UK and Ireland, it is also growing in Germany and Poland. Expansion is very much part of the strategy: they are rolling out stores in Austria this year. Expansion into Asia cannot be far off.

Tesco is able to generate nearly two-and-a-half times the dollar sales per square foot with its extraordinarily rapid inventory turnover, but TJX’s business model and merchandise offer deliver higher margins with lower fixed costs. Last year TJX generated an incredible after tax return on equity of over 50%, as compared with Tesco’s 13.6%.

It’s quite rare these days for retailers to be delivering such scorching return on capital but it’s not too difficult to work out why. Whereas Tesco has an operating profit margin globally of around 4%, TJX manages an operating margin, including occupancy costs and administrative expenses, of over 12%. Tight control of costs is clearly evident.

This may sound unscientific, but next time you have a chance, observe the punters queuing at the checkout at Tesco’s and then at TK MAXX. Which customers are smiling?

You can buy shares in The TJX Companies, Inc. on the NYSE. While the five-year and one-year graphs show a fairly smooth upward trend, the shares have fallen off since mid-August, along with the markets overall, and at time of writing are at $72.50. High capital expenditure to finance store expansion globally could restrain profit growth but one can realistically assume that EPS will continue to grow in double digits. Expect a share price of US$80-85 six months out as confidence in the company’s prospects solidifies.

[i] Emil Kraepelin originally described oniomania over a century ago, and he and Bleuler [1924] both included the syndrome in their influential early psychiatric textbooks. See Clinical Textbook of Addictive Disorders (2005). However, little interest was taken in compulsive shopping until the 1990s, and even in the 21st century the idea that compulsive shopping is a recognised mental illness is still controversial.

[ii] Calculation sheet available. The average human walking speed is 5 km per hour/ 3.1 miles per hour/ 1.4 metres per second.