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This Retailer Looks Like a Solid Buy

June 29, 2014 | About:
Vinay Singh

Vinay Singh

5 followers

I find it hard to resist following quite a few retail stocks. While it's true that retailers can fall in and out of favor, the great thing for investors is their businesses are relatively easy to understand. This is part of what attracts me to Ross Stores (ROST). The company has a great concept, is executing well, and seems to scream "buy."

Discount Retail Is Where It's At

If there is one thing that the Great Recession taught most customers, it is to shop for bargains. Customers who used to buy only name brands at traditional retailers found themselves shopping at stores they didn't frequent in the past. This is great news for Ross Stores.

Ross claims to offer prices of 20% to 60% off mid-priced department store prices. The key to the company's success has been opening new stores, and constantly changing their selection to keep shoppers coming back. This isn't to say that Ross is alone in this business. In fact, I would argue that competition in this space is even more fierce than before.

Ross' biggest competition has come from The TJX Companies main concepts of TJ Maxx and Marshalls. Both of these concepts offer deep discounts on fashion, home goods, and other items. In addition, Target is continually improving its fashion selection, and offering sales by brand name designers. Even Wal-Mart has focused on improving their fashion selection in the last few years. Even with all of this competition, Ross has been posting impressive growth.

Under-appreciated Growth

It's hard for me to believe, but it's right there in writing--Ross has been repurchasing shares for 20 consecutive years, and now has 19 years of dividend increases. This relatively unknown company is about to join the 20/20 club, which is something only select companies have achieved. If that's not a great reason to consider buying shares, I don't know what is.

A second reason to consider investing in the company is Ross' earnings growth. In the current quarter, Ross reported a 15% increase in revenue and a 25.88% jump in EPS. Analysts expect long-term EPS growth of 12.13%, which leads their peers. While Target is expected to grow earnings by 11.87% and The TJX Companies is expected to grow EPS by 11.56%, they can't match Ross. Wal-Mart's sheer size makes this type of growth difficult, and analysts are projecting about 9% EPS growth at the world's largest retailer.

A third reason investors should carefully consider Ross is the company has impressive free cash flow growth. While earnings can be manipulated, cash flow is a more accurate measure of real growth. I take this a step further by using a measure I call core free cash flow. I use a company's net income, plus depreciation, and then subtract capital expenditures. This measure eliminates some of the non-cash adjustments like asset and liability changes.

In the last year, only one company reported better core free cash flow growth than Ross, and that was The TJX Companies with 21.90% growth. Ross came in second with 18.99%, followed by Wal-Mart at 7.01% and Target at 1.6%. To be fair, Target was investing heavily in the last year to enter the Canadian market, so their measure might have been better without this investment.

Value For Shoppers, Value For Investors

Finally, Ross appears attractively valued when using a measure called PEG+Y. This calculation is something that Peter Lynch used when comparing companies that pay dividends. The PEG+Y takes the company's yield plus their growth rate, and then divides this results by their P/E ratio. A higher yield and growth rate, and lower P/E ratio will deliver the highest PEG+Y ratio. Unlike the PEG ratio, this is a case where the higher the number the better.

With Ross paying a 1.15% yield, and expected to grow EPS by 12.13%, their 15.41 forward P/E means the company's PEG+Y comes in at 0.86. The only one of Ross' peers with a better ratio is Target. Target pays a higher yield, has a slightly lower growth rate, but also a lower P/E ratio, and scores a 0.89. By comparison, The TJX Companies PEG+Y comes in at 0.76 primarily because of the company's higher P/E ratio. Wal-Mart scores just slightly better with a PEG+Y of 0.81. Since a higher PEG+Y ratio represents a better value, Ross comes in second in this comparison.

The biggest difference between Ross Stores and their competition is that Ross sticks to what it does well, and has a longer growth track. Originally the company thought the U.S. could support 1,500 stores, but now says 2,000 stores or more is possible. With just 1,091 stores currently, the company could theoretically double in size.

Ross' management team is also proving they put investors first. Last year the company repurchased $450 million in shares. In the next two years, the company is expecting to repurchase about $550 million. The company increased the dividend by 21% in the last year. With a core free cash flow payout ratio of just 27.01%, the dividend has room to grow further. The company has an impressive streak of share repurchases and dividend growth, and 2014 looks like another tremendous year.


Rating: 0.0/5 (0 votes)

Comments

Dr. Paul Price
Dr. Paul Price premium member - 5 months ago

How can you figure all those financial ratios without ever noting what ROST was selling for at the time you were writing about it?

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