Ross Stores Inc. (ROST, Financial) is a growth story in retail despite no online presence. The company uses buying and merchandising expertise to sell name-brand and designer goods for up to 70% less than conventional retailers.
It has more than 1,500 stores selling personal and home fashion through Ross Dress for Less and dd’s Discount. In coming years, it expects to grow the chains to at least 2,500 stores.
It currently has a place on the Undervalued Predictable list because the share price recently dipped about 4% below its 52-week high and because of consistency in growing its earnings. This one-year price chart shows the recent pullback:
It is a relatively shallow dip, but are there other reasons why a value or growth investor might be interested at this price?
History
According to the company's website, Morris Ross opened Ross Department Store in San Bruno, California in 1950. Over the next several years, more stores were opened and the company went public in 1985. Since then, the company opened its dd's Discount stores to serve customers with lower incomes and has expanded across the country.
Ross has existed, in one form or another, for more than three-quarters of a century. It Ă‚ has been a public company for 31 years and during that time has grown rapidly.
The business
Ross Stores operates two discount retail chains: Ross Dress for Less and dd’s Discount.
Ross Dress for Less sells name brand and designer apparel, footwear,and home fashions at 20% to 60% less than regular department stores. Its target market is middle-income households.
dd’s Discount sells essentially the same merchandise at prices that are 20% to 70% below those of conventional department stores. It targets consumers with lower incomes than Ross customers and are located in established shopping centers in densely populated urban or suburban neighborhoods.
The two chains operate independently, sharing only corporate and support services. They do share a target demographic: value-conscious women and men between the ages of 18 and 54. The company says decisions about merchandising, purchasing, pricing and store locations are driven by its customer profiles.
Despite its pricing, the chains stick to mainly top names because it is an important aspect of its success. Strategic buying allows the company to sell these products at discount prices. It buys almost all of its merchandise directly from manufacturers and says that by purchasing later in the buying cycle than other stores or chains, it can take advantage of imbalances between retailers’ demand for products and manufacturers’ supply of those products.
It also gets low prices by strategies and tactics such as not requiring promotional allowances and other incentives from manufacturers and flexible distribution. It also makes what it calls "opportunistic" purchases created by manufacturer overruns and canceled orders.
It has a packaway strategy that involves buying and storing merchandise for up to a year. Since the packaway usually involves fashion basics, it can be held over until the same selling season the following year. Packaway accounted for 47% of total inventories at the end of fiscal 2015. The company notes, “We believe the strong discounts we are able to offer on packaway merchandise are one of the key drivers of our business results.”
Like the retailing giant Wal-Mart (WMT, Financial), Ross Dress for Less and dd’s DISCOUNT adhere to a low operating cost strategy. That includes store design that provides a self-service format, use of labor-saving technologies, economies of scale and flexible store layout criteria for efficient space conversion.
Ross is an established expert in off-price and discount retailing. By purchasing strategically and opportunistically, it can profitably sell personal and home fashions for significantly less than conventional department stores.
Revenues
While Ross has only one reporting segment, it may be possible to get a sense of the informal segments with this slide from the November 2016 Investor Overview:
This GuruFocus chart shows revenue growth over the past 10 years:
GuruFocus reports Ross Stores’ revenue growth has averaged 10.4% per year over the past three years. That is better than its peers, but not as high as levels it previously set.
Ross has grown its topline consistently over the past decade. It generates revenues from a broad group of lines within the personal and home fashion niche.
Competition
Ross concedes that it does not operate in an easy space. It said, “We face a challenging macroeconomic and retail environment that creates intense competition for business from department stores, specialty stores, discount stores, warehouse stores, other off-price retailers and manufacturer-owned outlet stores.”
That tells us the competition still comes from other brick-and-mortar operations. Of online competition, it says it competes to some degree, suggesting that while it faces competition from online vendors such as Amazon (AMZN, Financial), it is not as difficult as traditional competition.
It cites three main competitive advantages:
- Meaningful discounts on branded merchandise.
- A well-balanced selection that appeals to targeted customers.Ă‚
- Convenient and easy-to-shop store environments.
To address these factors, it invests strategically in its merchandising organization and believes it is well positioned to compete on each factor.
Hoover’s lists its three main competitors as:
- Kohl’s Corp. (KSS, Financial)
- The TJX Companies Inc. (TJX, Financial)
- Wal-Mart Stores Inc. (WMT, Financial)
Retail is, and often has been, a highly competitive marketplace. The off-price and discount arena is no exception. Ross has developed and articulated a strategy to deal with this competition.
Moat
Morningstar gives Ross Stores a Narrow Moat rating.
The company argues it has several competitive advantages, as noted above. In its Investor Overview, it puts forward several key value drivers:
On balance, a narrow moat seems a reasonable assessment. It has shown an ability to manage effectively amid the intense competition. However, as the history of Wal-Mart tells us, moats can be eroded.
Growth
As noted, Ross has a history of growing its revenue. The same holds for two other key metrics (three-year averages):
- EBITDA at 12.6%
- EPS at 12.5%
- Revenue at 10.4%
Looking forward, the company sees itself growing from 1,535 stores to 2,500 stores in coming years:
Ross Stores should be able to continue growing its store count as well as its top and bottom lines with strategies and tactics that have served it well so far.
Other
Ross Stores is incorporated in Delaware and headquartered in Dublin, California.
According to reuters.com, the company's management has a strong history. Executive Chairman of the Board Michael Balmuth is a former president and chief executive officer of the company. He has been with the company since 1989. Chief Executive Officer and Director Barbara Rentler has held the CEO post since 2014. She has held several merchandising and management positions since joining the company in 1986. Chief Financial Officer and Group Senior Vice President Michael Hartshorn has held his position since 2015.
Ownership
Thirteen of the investment gurus followed by GuruFocus have Ross Stores holdings. PRIMECAP Management (Trades, Portfolio) has the largest at 14,850,100 shares, representing a 3.77% stake in the company. Pioneer Investments (Trades, Portfolio) and David Rolfe (Trades, Portfolio) are the second and third-largest holders among the gurus.
In a broader context, institutional investors (including pension, mutual and hedge funds) have a strong ownership presence:
Among insiders, the CEO, director and president and chief operating officer have substantial holdings:
At a little over 2%, the short sellers have a small position.
With a very high level of institutional ownership, investors might expect reasonable share price stability.
By the numbers
Current share price about 4% below the 52-week high (based on the Jan. 16 closing price); impressive ROA and ROE metrics; a small dividend with room to grow; and a significant number of shares repurchased.
Financial strength
The GuruFocus system awards Ross high ratings for both financial strength and growth and profitability:
This table also shows Ross earning a 9 out 9 on the Piotroski F-Score; according to the All-In-One screener, just 61 of the many thousands of stocks followed by GuruFocus score this well.
The table shows good use of debt and equity capital; the WACC (weighted average cost of capital) is 10.85%, while the ROIC (return on invested capital) comes in at 51.13%.
The company’s long-term debt has grown, as this chart shows, but not enough to cost it any points on the Piotroski F-Score:
Revenue has grown steadily over the past decade. While current growth is not as robust as it has been in the past, it still outpaces most of its peers. GuruFocus observes that its growth rate is higher than 79% of the 782 other companies in the Global Apparel Stores industry.
The EBITDA growth, again, is not as strong as it has been in the past, but it still outperforms most of its peers. GuruFocus puts the industry median growth rate at 1.9%, compared with 12.6% for Ross. This chart shows EBITDA growth over the past decade:
Free cash flow has grown, but not so steadily:
Ross Stores posts very good operating margin and net margin numbers:
- Operating margin: 13.79% (industry average 3.24%)
- Net margin: 8.58% (industry average 2.02%)
With so much of the retail industry going through hard times, the financial strength of Ross Stores presents a refreshing picture.
Valuations
Along with its financial strength, Ross also provides investors with a 5-Star (out of five) rating for Predictability, or consistent earnings growth.
At the close of trading on Jan. 16, with a price of $66.93, the Discounted Cash Flow calculator finds a 14% margin of safety:
The Ross price-earnings (P/E) ratio comes in at 24.61, which is comparable with TJX but significantly higher than Kohl’s or Wal-Mart:
Of course, the higher P/E ratios of Ross and TJX also line up with higher return on assets (ROA) and return on equity (ROE).
This chart of the P/E ratio over the past decade provides some context and shows it near the high end of its range:
The PEG (price-earnings divided by five-year average earnings growth) ratio is 1.37, which puts it in the middle of fair value territory.
Taken together, these metrics suggest Ross Stores is fairly valued or close to it.
Conclusions
Despite Amazon on one side and Wal-Mart on another, Ross Stores has found a niche in retail. There is little doubt this company knows how to navigate its way through the troubled waters of its industry. As it moves ahead, it should generate robust capital gains for investors.
Well, for some investors. Hardcore value investors will find the discount on the light side, but some will take exception to the company’s long-term debt. Income investors will not find enough yield to make it attractive.
For investors who want strong companies with good growth prospects, Ross Stores deserves a place on their shortlists.
Disclosure: I do not own shares in any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.
Start a free 7-day trial of Premium Membership to GuruFocus.
