This stock stands to benefit from the retail glut that Target warned about

Published Wed, Jun 8 20223:48 PM EDT

Kevin Stankiewicz @in/kevin-stankiewicz-b5593466 @kevin_stank

Target (TGT) warned Monday profits may take a hit in the near term as the big-box chain looks to shed excess inventory. It's a step other retailers will likely need to follow, analysts say, thus dragging down their stock prices. But not every retailer will take same hit. Some even stand to benefit from the inventory glut. One projected winner: TJX Companies (TJX). In fact, we think the discount retailer is the stock to own if you're looking for a way to bet on a wave of aggressive markdowns from retailers. The Club does not own the parent of TJ Maxx, Marshalls and HomeGoods, although we've held discussions about adding the stock to our bullpen . Our retailers right now are Walmart (WMT) and Costco Wholesale (COST). However, Target's announcement Monday is a significant event with implications for the retail industry and consumer spending more broadly. We recognize members may be looking for ways to invest in light of the news, and for that reason, we wanted to share our thinking on TJX and our current retail positions. Why TJX? TJX is what's considered an off-price retailer, along with the likes of Ross Stores (ROST) and Burlington (BURL). This is not a comprehensive investment case for TJX, and there's more analysis examining TJX's balance sheet and financial reports that must be done before feeling confident enough to buy a stock. However, we are always on the hunt for new ideas that benefit from the constantly evolving economic landscape, and we think TJX is well-positioned thanks to a few different reasons. One big reason is that persistently high inflation is squeezing consumers. Food and gas spending is essential, so people may actively seek out bargains on other purchases like apparel or home décor. That benefits TJX. On TJX's most recent earnings call, held May 18, CFO Scott Goldenberg said the company's research suggests "customers' perception of our value gap with other retailers remains strong," which is notable as there are questions about how well discretionary spending will hold up. Even if the overall pie gets smaller, it's possible TJX holds up better than other players. Another reason to like TJX is what Target warned about — inventory piling up in categories that consumers are spending less money on. While Target's excess stuff might not end up on the racks of TJ Maxx directly, Target is hardly alone in amassing a glut of inventory . In a note to clients Monday, Morgan Stanley analysts said their research finds softline retailers, which sell things like clothes and shoes, are "already over-inventoried." They warned that "markdowns [and] margin pressure may get worse from here." That could benefit TJX as other companies look to get rid of merchandise. Here's how TJ Maxx describes its approach to merchandising, according to the "How We Do It" section on its website: "We take advantage of a wide variety of opportunities, which can include department store cancellations, a manufacturer making up too much product, or a closeout deal when a vendor wants to clear merchandise at the end of a season. These are just some of the ways we bring you tremendous value." As for how that strategy applies to the current moment, Goldenberg painted a favorable picture on the aforementioned May 18 call. "I want to emphasize that in-store inventories are where we want them to be as we look at more normalized comparisons to pre-pandemic levels," the CFO said. "We still have plenty to open buy for the second quarter and second half of the year. We remain well positioned to take advantage of excellent deals we are seeing in the marketplace and flow fresh merchandise to our stores and online throughout the year." Put another way, TJX sees promising opportunities where others see near-term challenges. What the Street is saying We're not alone in our retail view. In a note to clients Tuesday, analysts at Citigroup highlighted a list of companies that they believe Target's disclosure is "most bad" for: Macy's (M), Gap (GPS), Levi Strauss (LEVI), Carter's (CRI), Children's Place (PLCE), Kohl's (KSS), Hanesbrands (HBI). The analysts, led by Paul Lejuez, hold a positive view on off-price retailers, especially TJX, for the rest of 2022. In the very near term, they said Target's decision to get promotional in categories like apparel and home goods is not great news for off-price retailers since consumers may just go directly Target to see what's on sale. However, Citi wrote, Target's plan to remove excess inventory and cancel orders is "is the type of disruption that typically leads to a favorable buying environment for off-price." That speaks to the CFO comments we referenced above. "We believe off-pricers (particularly TJX) are well-positioned for 2022 to capitalize on the confluence of impressive supply of goods at favorable pricing and more consumers trading down to find value," the Citi analysts wrote. Shares of TJX are down about 18% year to date, trading around $61.65 on Wednesday. The average price target on the stock is around $75 per share, according to analyst estimates compiled by FactSet. Just over 80% of analysts consider the stock a buy or have an overweight rating, according to FactSet. TGT's implications for Club stocks Let's turn our focus to the retail stocks we do own: Walmart and Costco. Of the two, Walmart is the one that's most similar to Target, so we will explain our thinking on it in more detail than Costco. But briefly on Costco: Costco is a wholesaler that relies on a membership model, which provides a significant boost to the company's bottom line. It's just a different type of company than Target. Plus, Target's lowered outlook was mostly about profitability in its second quarter because of the markdowns. In its May earnings report, Costco did not see the same degree of margin pressure that both Walmart and Target felt in their recent quarters. Walmart, like Target, did suffer from excess inventory in its first quarter, which the company reported May 17. At a high level, this makes the Bentonville, Arkansas-based chain exposed to the same forces that prompted Target's decision to more aggressively right-size its inventories. There are now questions about whether Walmart will be forced to issue a similar announcement to Target. When you drill down further, though, it's possible Walmart's exposure is at a somewhat lower magnitude because of the companies' different sales mixes. According to Bank of America analysts, general merchandise accounted for about 54% of Target's sales in calendar year 2021, compared with 32% for Walmart in the U.S. This difference in sales mix is one explanation why Walmart also has lower margins than Target to begin with — 5% operating margin in fiscal 2022 versus Target's 8.5%. Additionally, Walmart already dramatically revised its earnings expectations in May, saying it now expects earnings per share to decline about 1% this year compared to its prior forecast of a mid-single-digit increase. Target, by contrast, just did not provide a full-year earnings outlook when it reported first-quarter results in May. To be clear, we're not saying Walmart is operating in an ideal environment right now. Far from it. It's a tough landscape for retailers including Walmart, but we are saying there are ample reasons why Walmart may not issue a revision to its margin guidance like Target had to do. (Jim Cramer's Charitable Trust is long WMT and COST. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Annapolis, Maryland, on May 16, 2022

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