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Discount Retailer Ross Stores Proves to Be a Recession-Proof Business
Posted by: Patricio Kehoe (IP Logged)
Date: March 13, 2014 04:58PM
While 2009’s economic recession was a serious problem for many businesses, particularly in the retail area, off-price retailers were some of the few which actually benefitted from the crash and weak recovery phase. Ross Stores Inc. (ROST) was one of the retailers that gained market share thanks to consumer’s price oriented behaviour. However, the company’s large buyer fleet has also contributed significantly to its past growth. With 600 merchants and 8,000 vendors at hand, the firm has strong pricing power and has used it in the past to obtain trendy designer wear at the lowest prices possible.
Profitability is a class of financial metric used to analyze a business’ ability to generate earnings, compared with expenses and other relevant costs incurred during a specific period of time. There are several profitability metrics, but I will be looking at return on assets, quality of earnings, cash flows and revenue. By analyzing these four metrics, we will be able to elucidate if the company is really making money.
ROA - Return On Assets = Net Income/Total Assets
ROA indicates how profitable a company is relative to its total assets, and also gives us an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage.
Quality of Earnings
Quality of earnings is the amount of earnings attributable to higher sales or lower costs, rather than artificial profits created by accounting anomalies. In order to assess Ross Stores' quality of earnings we will compare the level of income with operating cash flows.
Large Scale and Attractive Products
Although the discount retail industry in plagued with competition, such as TJX Companies Inc. (TJX)’s T.J. Maxx, Zara, Kohl’s Corporation (KSS), or H&M, Ross remains the largest single brand in the U.S, with its 1,131 stores. In fact, the company’s scale has allowed it to earn a growing market share, as well as bargaining power over designers. Since there are only two or three major players operating in the same segment as Ross, consumers are bound to turn to this discount store for their specialty apparel and designer names, thereby guaranteeing consistent sales growth.
Working Capital indicates whether a company has enough short term assets to cover its short term debt. While anything below 1 indicates negative W/C (working capital), a ratio over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.
The gross profit margin is important because it tells investors what percentage of revenue/sales is left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors is more efficient, and consequently investors will pay more for those businesses, given their ability to make a decent profit as long as overhead costs are controlled.
Asset turnover measures a firm's efficiency in using its assets to generate sales or revenue - the higher the number the better. It also indicates pricing strategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover.
Several institutional investors have been buying Ross Stores’ stock in the recent quarters. This is important because hedge funds use strict fundamental procedures before investing in a stock. Last quarter, for example, investment gurus Chuck Akre (Trades, Portfolio) and Steven Cohen (Trades, Portfolio), among others, bought the company’s shares at an average price of $76.01.
Currently, many analysts also have a good outlook for Ross Stores. While Analysts at MSN money are predicting that the firm will retrieve a solid 25% EPS growth rate, closing EPS at $4.37 for FY 2014, Bloomberg’s analysts are estimating revenue to hit the $11.03B mark for FY 2014, coinciding with the company’s 14.9% revenue growth rate. Moreover, on 25/09/2013, Goldman Sachs gave Ross Stores a rating of "Conviction Buy" with a target price of $78.28, implying significant upside potential from this point.
The profitability analysis has made clear that Ross Stores is definitely a worthwhile long term investment. Between its more than healthy balance sheet, consistent returns on invested capital, and savvy business model, I believe future profits should be no problem whatsoever for this discount retailer. Furthermore, the on-average stock trading price of 18.4x trailing earnings should be more than tempting for investors looking to gain healthy profits in the medium term future.
Dislcosure: Patricio Kehoe holds no position in any stocks mentioned.
Guru Discussed: Chuck Akre: Current Portfolio, Stock Picks
Stocks Discussed: ROST, TJX, KSS,