Off-price retailers poised to take even bigger market share from department stores

Ahead of earnings reports from major off-price retailers, several analysts have acknowledged the strength of the sector, which tends to do well in growing and declining economies, with customers spanning a wide range of incomes. These retailers also have an advantage in real estate, with most located far from malls in small towns with convenient parking, and they are poised to grab market share as Macy’s works through its planned 150-store closure.

UBS analysts led by Jay Sole also noted that online sales of clothing and footwear have plateaued, which is good for this segment, which relies more on brick-and-mortar stores than e-commerce.

“As consumers are pressured by inflation and mounting debt, discretionary items are taking a back seat to spending,” analysts at Jane Hall & Associates wrote in a note to clients last month. “However, when consumers shop for discretionary items, they are looking for value. Both TJX and (Ross) have consistently been buying strongly and leaning into categories and products that consumers are interested in. Additionally, the off-price sector is poised to benefit from retail store closures and the current weakness in the department store sector.”

Here are the latest reports from major OTC players who have raised their guidance for the year following the release of their second-quarter results:

TJX Cos.

At TJX Companies, which operates a variety of off-price retail stores in the U.S., Canada, Europe and Australia, second-quarter net sales rose 5.6% year over year to $13.5 billion, and comparables rose 4%, “driven entirely by growth in customer transactions,” according to a company news release. Comparables at USTJ Maxx-plus-Marshalls, known as Marmaxx, rose 5%, and comparables at its U.S. HomeGoods business rose 2%. Marmaxx is the company’s largest business, with $8.4 billion in the period.

Gross margin rose just 0.2 percentage points to 30.4%, and net income rose 11.1% to $1.1 billion. Chief Financial Officer John Klinger told analysts the company expects the decline to be flat from a year ago.

“We believe TJX has the potential to capture significant market share from its department store peers over the next few years,” UBS’s Sole said in a research note after the company’s Q2 earnings report. “In addition, we believe TJX’s newer businesses, such as HomeSense and Sierra Trading Post, have significant potential, as does its international business.”

Ross Stores

Ross Stores, which operates 1,795 namesake stores in 43 states, the District of Columbia and Guam, as well as 353 DD’s Discounts stores in 22 states, has been growing rapidly, recently opening 24 new locations in two months. Second-quarter net sales rose 7.1% year over year to $5.3 billion, with comparable sales up 4%.

Operating margin increased 115 basis points to 12.5%, and net income increased 18.1% to $527.1 million, driven by higher sales and lower distribution and incentive costs, partially offset by lower merchandise margins.

In a statement, Chief Executive Barbara Rentler cautioned that while the company beat its own expectations during the period, its year-over-year comparisons could become more difficult in the second half of the year. Still, the company’s low- and middle-income consumers are responding well to its merchandising, according to Bank of America analysts Lorraine Hutchinson and Melanie Nuñez.

“A sharper value strategy for good, better and best products is attracting customers at both Ross and dd’s,” they wrote in a note to clients. “Average retail sales increased slightly, consistent with this branded strategy, while units per transaction decreased. This strategy is key to attracting the value-driven customer and will lead to market share growth, but we expect margin pressure in the near term as value is passed on to the customer.”

Burlington

New stores are also key to sales growth in Burlington, CEO Michael O’Sullivan told analysts Thursday. The company added a net 36 stores to its fleet in the second quarter, for a total of 50 net new stores this year — ending with 1,057. The company expects the location to do about $7 million in its first year of operation, and the new stores are beating that total, he said.

In Q2, net sales rose 13.4% year over year to $2.5 billion, with comparable sales up 5%. Gross margin increased 110 basis points to 42.8%, and merchandise margin increased 90 basis points, primarily due to lower markdowns but also lower transportation costs. Net income more than doubled to $73.8 million, from $30.9 million a year ago.

“We continue to be pleased with the broad and sustained momentum for sales in Burlington, despite broader concerns about the health of lower-income consumers,” William Blair analysts led by Dylan Carden said in a note to clients on Thursday.

In fact, in addition to the expansion, the retailer has benefited over the past year and a half as the financial situation of many households has improved, O’Sullivan said.

“Two years ago, our core low-income customer was under significant economic pressure due to the higher cost of living. Since then, two things seem to have happened. As inflation has come down, the situation has improved somewhat for lower-income customers. At the same time, the economic pressures and uncertainty have spread and extended far beyond the lower-income customer,” he said. “There is now a greater emphasis on value across demographics and income brackets. That greater emphasis on value helps our business.”