Two Major Retailers Set to Benefit From a New Tax Break

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TJX Companies (NYSE: TJX) has been expanding at a healthy rate in recent years, as the company capitalizes on the growing popularity of off-price stores. Meanwhile, Target (NYSE: TGT) is in the midst of an aggressive investment cycle, as management tries to bolster the company's e-commerce and omnichannel retail capabilities.

In this segment from Industry Focus: Consumer Goods, the cast discusses how one piece of the tax reform bill will help TJX and Target pay for the big investments they're in the process of making. The provision for "expensing" capital investments could even encourage these companies to increase the pace of their spending in the next few years.

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A full transcript follows the video.

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This video was recorded on Feb. 13, 2018.

Vincent Shen: With the traditional brick-and-mortar retail space, there's a lot of trends that are changing the sector, whether it's omnichannel, new store formats, experiential retail, among others. So for the companies that end up putting the savings back into their businesses and operations, what does that potentially look like?

Adam Levine-Weinberg: There's an extra benefit for companies that want to reinvest the tax law savings. One of the interesting things in this tax law is, it implements a temporary cut in the cash tax rate for companies that are investing in the business. Instead of having to depreciate investments over a period of, it could be five, 10, or even 20 years, between now and 2022, companies will be allowed to expense 100% of their capital spending, which means that they can write it off all in the first year. That's an immediate tax deduction for them. That creates a lot of additional cash flow, because theoretically, a company that's reinvesting all of its cash flow could actually pay no taxes, even if it's posting pretty high profits, because it's getting all of these write-offs from its capital spending.

Among the retailers we've been looking at, none of them are investing quite that heavily, but there are definitely some that are putting more money into the business right now. TJX, which is the parent company that runs the popular TJ Maxx and Marshalls and HomeGoods chains in the U.S., that's definitely a company that's been spending at a pretty high rate to expand. It's adding square footage of about 5% a year in recent years. It could potentially even speed up its expansion even more going forward. Just in the past few years, it started to test out some new store formats for the United States to potentially give it even greater growth opportunities.

The first one that came about was Sierra Trading Post, which was a mainly online off-price retailer that it had acquired a few years ago, and it started opening some Sierra Trading Post retail stores. It's learned a lot from that. It seems to be figuring out how to make those work. And now it's started to ramp up that expansion. With the new tax law benefits, it's possible you'll see that expansion move even faster. A second area where it's experimenting is in the home market, because the HomeGoods chain has been by far the most successful in terms of comp sales growth and total sales growth in recent years. Now, TJX is testing a second home store format called HomeSense in the United States. It sees that as a way to tap into some different segments of that home market and further expand its growth. The idea is that, kind of like TJ Maxx and Marshalls have some overlap but also some differences, by offering two different home store concepts, TJX could significantly expand its long-term growth potential.

Those are two areas where you could definitely see TJX ramping up investment because of the benefits of this tax law. Then, aside from that, TJX will have more cash flow that it can return to shareholders. It's been raising its dividend at a pretty healthy rate in recent years, and it's also been buying back a lot of stock, so I'd expect to see more of the same in 2018 and beyond.

Shen: Another company that you pointed out before the show, too, that has announced recently some pretty big plans to up their spending, try and claim more market share, do some store remodeling, things along those lines, is Target. How much of a beneficiary do you think the company could be from these new rules that we've talked about so far?

Levine-Weinberg: Target isn't growing as quickly as TJX, but it is opening up some more small-format stores in the United States. This is its best way now to penetrate the markets it hasn't been able to get into up until now. Beyond that, it's investing really heavily in remodeling the stores, improving its technology and fulfillment so that it can capture a bigger share of online stores.

Really, if you look at the last 10 years of Target, the company made two really, really big mistakes that have held it back from its full potential. The first was, it got caught up in trying to expand into Canada, and that was just a complete disaster. It had to write off billions of dollars when it pulled out. And that also obviously diverted a lot of management attention. The second one was, years and years ago, it outsourced all of its e-commerce to Amazon, which gave Amazon a huge amount of data and meant that Amazon could run Target's business to not compete very much with Amazon's online business.

So Target has taken control of its own e-commerce operations again, but it still has a long way to go to improve its ability to serve that e-commerce market and try to gain some market share there, because right now, it's growing quickly but still quite small compared to the total company. So those are definitely areas where Target needs to invest, so the tax law is really convenient, because it will reduce the pain from those investments by creating some offsetting tax breaks.

Shen: I'm looking at Target's income statement here, and it's interesting. The tax savings, again, with the reduced rate for this company, the savings could come out to about half a billion dollars. If we keep in mind that, this time last year, that was when management announced they'd be doing the big push on their investment, spending $7 billion to gain market share, to develop that e-commerce platform, like you mentioned. So those investments, they said, would be spread out over three years. That's about $2.3 billion per year. If these recent tax savings come out to over half a billion dollars, they can make up almost a quarter of the annual spending that the company has planned, so pretty significant.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Levine-Weinberg owns shares of The TJX Companies. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends The TJX Companies. The Motley Fool has a disclosure policy.