Inflation and rising interest rates may send investors searching for stocks that can pass on added costs quickly to customers.
Margaret Samuel names three consumer staples stocks that can quickly pass on costs, such as inflation and higher interest rates, to customers.
While the market has been on a steamy rise upward for the last few years, there may be reason to expect a meaningful correction. In particular, a change in the wind that would merit such an expectation would be a combination of strong inflation and higher interest rates.
In this milieu, investors may be looking for places to hide.
One area would be a place where inflation can be passed on quickly to customers, for example in the consumer staples sector. Three stocks that could fall into this category are Walmart, Dollar Tree and TJX.
Walmart Inc. (NYSE—WMT)
Located throughout Mexico, India, China, Chile, Central America, Canada, Africa and the US, Walmart Inc. produces annual revenue of about $572 billion, and is engaged in the operation of wholesale, e-commerce, retail and other units. Walmart offers a range of services and merchandise at everyday low prices. The company operates approximately 10,500 stores, e-commerce websites and clubs in 24 countries under 48 banners. The three segments through which it operates are: Sam’s Club, Walmart International and Walmart US. The Walmart US segment encompasses the mass merchant concept in the US. The Sam’s Club segment includes the warehouse membership clubs in the US. The Walmart International segment consists of the company’s operations outside of the US.
In its recent third quarter report, Walmart increased its guidance for adjusted earnings per share to $6.40 from a previously expected range of $6.20-$6.35. In addition, Walmart’s adjusted earnings per share in the nine months ended October 31, 2021 increased 20.8 per cent compared to the same 2020 period. So, Walmart is not only projecting increased profitability going forward, in the recent past it has also shown investors the money.
Walmart generates a return on equity of 9.31 per cent, pays a 1.52 per cent dividend, with a conservative 76.57 per cent payout ratio. Although its PEG ratio of 3.20 and its price-to-book ratio of 4.75 are not a screaming buy, they are also not wildly unreasonable.
In its Walmart International segment, market growth was retained, but net sales and its gross profit rate declined, largely because of divestitures. In the third quarter, the Sam’s Club segment increased net sales and decreased its operating expense rate both with and without fuel. While some of Walmart’s third-quarter performance in its Walmart US segment benefited from seasonal holiday sales, Walmart attributed some of the third-quarter growth in this segment to market share gains, COVID vaccine administration, and “low-to-mid single digit ticket inflation”.
Thus, with the ability to pass on inflationary pressures relatively quickly to its customers, Walmart is well suited with a strong balance sheet and proven profitability to thrive in an inflationary environment.
Dollar Tree Inc. (NASDAQ—DLTR)
Dollar Tree Inc. generates annual revenue of about $26 billion and operates discount variety stores. The company’s business segments include Family Dollar and Dollar Tree. The Family Dollar segment operates neighbourhood, general merchandise retail discount stores. The Family Dollar segment consists of distribution centres and store operations under the Family Dollar brand. The merchandise of the Family Dollar stores segment includes pet food, batteries, diapers, consumables, automotive supplies and hardware. The discount variety stores operated by the Dollar Tree segment sell merchandise primarily at a fixed price and operate under the brand names Dollar Tree Canada and Dollar Tree, with distribution centers in Canada and the US.
Having increased its merchandise price point from $1 to $1.25, Dollar Tree is able to offer a wider range of products to its consumers, with a higher profit margin, which will continue to support its earnings generation. Dollar Tree’s President and CEO, Mike Witynski, confirms “broad consumer acceptance of the new price point and excitement about the additional offerings and extreme value” it is now able to provide.
Investors may be wary that operating income of $310.5 million was lower in the 2021 third quarter than $465.5 million for the same 2020 quarter, and that net income of $.96 per share was lower than $1.39 per share in the 2020 third quarter. However, with 125 new stores and expanding or relocating 34 stores, Dollar Tree is building to generate future growth. In addition, in the first nine months of the fiscal year, net sales increased 2.6 per cent compared to the same period in 2020, operating income grew 2.2 per cent to $1.23 billion, and net income improved 4.1 per cent to $873.7 million compared to the prior year nine-month period.
Although it does not pay a dividend, trading at a PEG ratio of 1.77, Dollar Tree is reasonably priced compared to its growth, with some room to increase in price. This, considered together with its sound return on equity of 19.38 per cent, and growing 9-month year-over-year sales, income, and capital investments, makes Dollar Tree potentially attractive to investors who are willing to rely on the prospects of capital gains rather than dividends for portfolio performance. Indeed, in its fiscal 2021 third quarter report, Mr. Witynski confirmed that Dollar Tree “experienced a strong finish to the quarter, as shoppers are increasingly focused on value in this inflationary environment”.
The TJX Companies, Inc. (NYSE—TJX)
Some retailers sell high-quality goods at cheap prices, usually by selling second-hand goods or off-season items. These are known as off-price retailers, and The TJX Companies, Inc. is one of them. With annual revenue of about $46 billion from the US and around the world, TJX operates through four segments: TJX International, TJX Canada, HomeGoods and Marmaxx.
First, TJ Maxx and Marshalls chains in the US comprise the Marmaxx segment with 2,402 stores. Second, operating through an additional 821 stores in the US, the HomeGoods chain is an off-price retailer of home fashions. Third, the TJX Canada segment operates Winners, an off-price apparel and home fashions retailer, HomeSense, offering the home fashions off-price concept, and Marshalls. Fourth, The TJX International segment runs the TK Maxx and HomeSense chains in Europe, including approximately 602 TK Maxx stores in the Netherlands, Austria, Poland, Germany, Ireland and the UK.
In its fiscal 2022 third quarter report, The TJX Companies, Inc. announced that net sales increased 64 per cent in the first nine months of fiscal 2022 compared to the same 2021 period, to $34.7 billion and that they increased 18 per cent compared with the first nine months of fiscal 2020. This means that even adjusted for the COVID-related store closures in fiscal 2021, net sales are trending upwards. This was the case for each of its four segments. Cash flow generation is also strong, with $1.0 billion of operating cash flow generated in the third quarter of fiscal 2022, which The TJX Companies ended holding $6.8 billion of cash.
TJX trades at a very attractive PEG ratio of .17 which means that it appears to be inexpensive considering its growth rate. With a low payout ratio of 35.62 per cent, an investment in TJX may allow investors to rest assured that its dividend of 1.46 per cent is reliable for the foreseeable future. In total, The TJX Companies returned $2.0 billion to shareholders during the nine months ended October 30, 2021, with a combination of share repurchases and shareholder dividends.
Moreover, if we are wrong in expecting that there will be inflation and that TJX can support its profitability by passing on price pressures quickly to consumers, this company’s strong return on equity of 44.43 per cent leaves room for error. Due to the continued uncertainty of the COVID-19 global pandemic, The TJX Companies, Inc. announced that it is not providing financial guidance at this time. Nonetheless, CEO and President Ernie Herrman confirmed on November 17, 2021, that: “We are very confident in our ability to continue to gain market share, improve our profitability in the medium to long term, and reach our strategic vision of TJX becoming a $60 billion company.”
Margaret Samuel, MBA, LL.B., CFA is President, CEO and Portfolio Manager of Enriched Investing Incorporated. She can be contacted at info@enrichedinvesting.com. She or clients of Enriched Investing™ may hold positions in the securities mentioned. The information provided is general in nature and does not represent investment advice. It is subject to change without notice and is based on the perspectives and opinions of the writer only. It may also contain forward-looking statements that may not prove to be accurate. Every effort has been made to compile this material from reliable sources; however no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please consult an appropriate professional regarding your particular circumstances.
This is an edited version of an article that was originally published for subscribers in the January 2022, Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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The MoneyLetter •3/31/22 •