Costco and TJX Companies should be able to manage the emerging transition to deflation by leveraging their deep value propositions to get customers to buy more. As inflation headwinds continue to ease, and perhaps at some point become tailwinds, their competitors will be able to better compete on price. So, Costco and TJX-owned T.J. Maxx, Marshalls and HomeGoods must stay on their games. The economy has been shifting from decades-high, Covid-fueled inflation to a period of disinflation. The consumer price index closed out 2023 with inflation continuing to cool. Excluding food and energy, core CPI rose 3.9% year over year , the lowest reading since May 2021. The Federal Reserve’s favorite inflation gauge, the core personal consumption expenditures price index, showed a 2.6% year-over-year increase in December. The Fed targets 2% as a healthy annual inflation rate. The question currently facing investors is whether the Fed will starting cut rates soon to pad the runway for an economic soft landing, which could boost the stock market. Signs of a resilient economy, however, have clouded that picture on worries that cuts could heat things too much and stoke inflation. The most recent example of an economy that won’t quit was on Friday when the government’s monthly look at job growth crushed estimates in January. In its epic battle to squash inflation, the Fed started raising rates in March 2022. It did so 11 times since then. Disinflation – which means inflation is still present, but prices are rising at a slower rate – has been the reward for slamming on the brakes. Deflation would be a step further as it’s when price levels actually decline. Wall Street sees a combination of both deflation and disinflation across most categories within retail. “Inflation has been moderating pretty consistently for the past several months, especially on the food side but also in other categories like general merchandise, apparel, and home items,” said Joe Feldman, analyst at Telsey Advisory Group. At warehouse retailer Costco, Jim Cramer observed that the company is “starting to see deflation” since it “had zero growth in pricing,” in its latest quarter. In its fiscal 2024 first quarter , reported in mid-December, Costco said it has been seeing deflation in some items, which has resulted in sales of those units going up. For example, management saw deflation in bigger items like furniture sets due to lower year-over-year freight costs. Average sale prices on other items like TVs have been lower while unit sales have gone higher. In its private label, Kirkland Signature prices were “flat to down a couple percent, while units were up in the mid-teens” on a percentage basis, CFO Rich Galanti said on the company’s post-earnings call. Galanti also addressed the solution, saying the way to offset this is to “drive people and frequency.” He added, “As long as we see renewal rates continue to do what they do, as long as we see new sign-ups continue to do what they do, hopefully, continue to get people to convert to Executive as well, and constantly driving the best value out there.” Costco is known for its volume-based sales strategy, which maximizes thin margins. Membership fee revenue is some of the glue that allows Costco to keep prices so low. Deflation can be a double-edged sword. In the near term, it’s a positive for consumers who get relief from higher prices of goods and services. It also lowers extra costs for retailers like commodity and shipping expenses. But if persistent over time, deflation is usually a signal of a weakening economy, which could lead to softer consumer demand and a buildup of inventory which forces retailers to lower prices. While deflation is a valid concern for the retail sector more broadly, Costco and off-price retailer TJX can offset this risk because their business models allow them to be consistent market share gainers in their specific areas of the retail industry even during volatile economic periods. Shares of both Costco and TJX hit all-time highs on Friday. COST 1Y mountain Costco 1 year Over the past couple of years, Costco has experienced strong sales across food and sundries, fresh food, and non-food categories as prices increased. While trying to keep prices low, and it does so better than any other retailer, inflation did force Costco to raise price some, which led to higher revenue. Costco is a top-line-driven company so to mitigate deflation risk, Feldman explained, the company would need to increase revenue either by selling more units and/or through pricing. The latter option is narrowing. While sales continue to be strong, in fiscal Q1, Costco noted that inflation slowed to flat to up 1%, meaning Costco may not be able to raise its prices as much as it had before. What we like as long-time investors in Costco is that it doesn’t rely on solely on price to make money. In fact, the membership-only retailer prides itself on being able to keep prices lower than competitors in inflationary and disinflationary times. Costco always says it will be the last to raise prices in an inflationary environment and the first to lower as soon as pressures ease. Costco can boost sales in either scenario by “encouraging its members to buy more items to get more savings,” Feldman said. The methods Costco has at its disposal to stimulate more spending is to “provide more value through the pack size or do more to market the goods,” he added. Remember, value is not only about price. It’s also about what providing consumers are great bang for their buck. As prices continue to come down, Costco’s operational costs should also drop, making it easier for the retailer to price their goods at a sharper discount for members versus traditional retailers, all while remaining profitable. “They’ll be able to maintain their price gap with the competition to show that there’s still tremendous value,” Feldman said. Costco’s plan, he explained, is likely to get consumers to spend more merchandise from the same total basket size. As commodity and shipping costs come down too, management can also put pressure on vendors to give them better pricing, which is then also passed along to Costco members. Another benefit to Costco is “traffic is up rather strongly and the average number of items per basket has been relatively stable to up,” Jefferies said in a recent research note. If pricing becomes a headwind, analysts added, Costco could raise its membership fees. This is a catalyst we’ve been waiting for that’s overdue given the company has historical hikes every five years or so. The last increase was in 2017. A second catalyst that Costco shareholders had been waiting for happened in fiscal Q1: a special dividend. Costco is set to report its fiscal 2024 second quarter March 7. Next week, it will results January sales. Unlike most companies, Costco issues sales monthly, giving investors a more real-time look at business. TJX 1Y mountain TJX Companies 1 year Another hope among the retail sector, Feldman said, is as prices come down, consumers may have more money to spend on discretionary goods while still looking for value. That could help stimulate demand for discretionary purchases at TJX. TJX tends to be well positioned in any kind of economic environment but would not be immune to deflation. Like Costco, Feldman said the off-price retailer would need to increase revenue either through price or number of units. The good thing is, TJX’s business model keeps prices at a discounted rate and that helps them execute better, the analyst explained. “TJX can be more aggressive with their pricing given the strength of the customer base. They can drive more volume than most,” according to Feldman. Back in November, TJX reported strong results for its fiscal 2024 third quarter , which by calendar year is the three-month period that ended Oct. 28, 2023. At the time, management was forced to shave the company’s fiscal Q4 guidance range to reflect a 3-cent-per-share expense that was pushed out from the third quarter. The stock took a 3% hit that day. But we thought it was nitpicking and judging by its 9% increase since then Wall Street came around to our view of things. TJX is set to report its fiscal 2024 fourth quarter on Feb. 28, which includes the holiday shopping season. We’ll be studying the release and the post-earnings conference call for the first look at TJX’s fiscal 2025 guidance, or by the calendar year 2024. (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. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . 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Costco and TJX Companies should be able to manage the emerging transition to deflation by leveraging their deep value propositions to get customers to buy more. As inflation headwinds continue to ease, and perhaps at some point become tailwinds, their competitors will be able to better compete on price. So, Costco and TJX-owned T.J. Maxx, Marshalls and HomeGoods must stay on their games.
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