Nimble retailers Costco, TJX to benefit from improving supply chains, Cowen says
After more than two years of shipping and delivery disruptions, global supply chains are normalizing and retailers like Costco (COST) and TJX Companies (TJX) are poised to reap the rewards, according to Cowen Research. The Club holdings have long proved to be more adept than many competitors at managing their inventories and flexibly responding to upheaval in the supply chain, a key pillar of our investment case for both. Over the past year, Costco has "demonstrated an effective supply chain response… while prudently managing inventory levels relative to sales," analysts at Cowen wrote Monday in a cross-sector research note on global supply chains. At the same time, the bank called TJX its "top pick within off-price retail for supply chain margin recovery." The retail industry has been weighed down by a global supply chain crisis in the wake of the Covid-19 pandemic. Demand for consumer goods soared, while logistical constraints and bottlenecks limited the availability of those products. Ultimately, as more dollars in the economy competed for fewer goods, inflation climbed this year – with a stronger U.S. dollar further putting pressure on retailers' overseas operations. But with the Federal Reserve aggressively raising interest rates to suppress demand and rein in inflation, supply chain bottlenecks are now beginning to ease. In addition to nimbly navigating supply chain hurdles, membership-only wholesaler Costco, which sells everything from groceries to gasoline in bulk, and TJX, which operates off-price stores like T.J. Maxx and Marshalls, both have business models suited to consumers in an economic slowdown. Cowen's take Costco's supply chain this year has been interrupted by port delays, shortages of raw materials and labor costs. But the company has managed these disruptions in part through its "immense buying power," allowing it the leverage to negotiate with a range of suppliers to extract the best prices, according to Cowen. Costco's buying power is enabled by the company's limited stock keeping units (SKUs), a metric that helps retailers track inventory and sales. A lower SKU count means a retailer has less product categories, making it easier to manage inventory. Costco's "shelves remain stocked based on an item focus rather than a category focus," Cowen analysts wrote, and are concentrated on consumer staples. Analysts at Bank of America on Tuesday said Costco's "curated and limited SKU count" is a "competitive advantage as it allows the company to more frequently rotate in new and high-value items." By contrast, discount retailers Walmart (WMT) and Target (TGT) both have higher SKU counts than Costco, as they offer a greater variety of inventory categories. This higher volume of inventory ultimately posed challenges for both retailers earlier this year when they were left holding merchandise that didn't keep up with changes in consumer spending preferences, forcing them to markdown prices. Costco has benefited as U.S. consumers have been shifting their spending habits away from discretionary purchases like electronics to focus on essential items like groceries. In a separate note Tuesday, analysts at Cowen called Costco a "defensive play" and "one of the best positioned retailers to win market share over the coming quarters during and after the pandemic," citing a "streamlined assortment" of products that can continue to spur sales growth in a slowing economy. But as supply disruptions improve, retailers are receiving goods earlier than anticipated, often resulting in built-up inventory, according to Cowen. The analysts said they expect that oversupply to continue, which would benefit an off-price retail operator like TJX that buys excess inventory at a discount. Unlike competitors Ross Stores (ROST) and Burlington Stores (BURL), TJX maintained its fiscal year 2022 gross margin at pre-Covid levels, at 28.5%, despite headwinds from supply chain and freight costs, according to Cowen. The analysts expect a slight margin contraction in fiscal 2023, due to elevated shipping costs, before expanding as high as 28.8% in fiscal 2024. The Club take We agree that Costco's negotiating power is a strong asset that allows it to offer the best value to customers. Furthermore, since Costco's inventory is focused on consumer staples, there's less risk of inventory obsolescence. That means consumer demand will likely not dissipate for most of its items, limiting the inventory build up seen by Walmart and Target. Inflation has pressured Costco's margins but that headwind has been mitigated by the wholesale retailer's strong membership- and total sales growth. Furthermore, we see an opportunity for margin expansion, given the company's plans to open more stores internationally. On TJX, we agree that supply chain volatility creates opportunities for the off-price retailer, as its business model targets name brands struggling with excess supply. At the same time, we believe TJX's margins will expand as freight headwinds reverse next year. (Jim Cramer's Charitable Trust is long COST, TJX. 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. 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A man loads water into his car in the Costco parking lot in the Brooklyn, New York, March 2, 2020. Andrew Kelly | Reuters