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Robert Abbott
Robert Abbott
Articles (296)  | Author's Website |

Ross Stores: Off-Price, but Not Off Course

A retailer that thrives, despite Amazon.com and a host of other online challengers

April 20, 2018 | About:

Its stores will never win any prizes for décor or anything else important to brick-and-mortar retailers, but Ross Stores Inc. (NASDAQ:ROST) has won the loyalty of its moderate- and low-income customers.

So much so that it has a lot of green and favorable numbers on its GuruFocus dashboard:

Ross Stores financial dashboard

Its 10-year price chart has bumped up and down at times, but generally has maintained its upward trajectory:

Ross Stores 10 year price chart

In its most recent 10-K, for the fiscal year ended Feb. 3 (fiscal 2017), Ross describes itself as the operator of two brands of off-price retail apparel and home fashion stores: Ross Dress for Less and dd's Discount. At the end of fiscal 2017, it operated 1,409 Ross stores (all domestic) and 213 dd's Discount stores.

It targets value-conscious men and women between the ages of 18 and 54; all strategic decisions are based on these customer profiles. Prices range from 20% to 70% below the prices at most department and specialty stores. A major part of its strategy involves the use of self-service to keep labor costs down.

Ross obviously looks like a strong stock so far, but does it have the underlying numbers to bear out that optimism? For an initial answer to that question, we use the Macpherson model (information about the model available here and here).

The first set of criteria refers to the company’s financial strength (data from GuruFocus, after the close on April 19):

Ross Stores financial strength

Ross receives one fail and three passes; the fail being on debt, which amounted to $312 million at the end of fiscal 2017. At the same time, it held cash of $1.29 billion, which gives it a 3.25 cash-to-debt ratio. The three passes are all solid, and well above the threshold.

The second set of criteria refers to the company’s moat, its competitive advantage. Again, the results are well above the thresholds:

Ross Stores moat

Finally, a set of criteria that establishes an initial valuation through discounted cash flow analysis:

Ross Stores valuation

While both types of DCF show Ross stock is undervalued, GuruFocus says earnings-based DCF is the most suitable. This offers a 28.3% margin of safety.

Considering the information in these tables, Ross Stores is a non-starter for value investors because of its debt. It may be of interest to growth investors, however, given the strong numbers it generates.

Other financial data

  • Revenue: Its three-year revenue growth rate averages 11.70% per year.
  • Margin: Operating margin currently stands at 14.49%.
  • EBITDA: A three-year, average growth rate of 14.30% per year.
  • Dividends: The current cash dividend is 22.5 cents per quarter, or 90 cents per year. That translates into a yield of 0.89% and a payout ratio of 1.8%.
  • Buybacks: The three-year average share buyback ratio is 2.50.
  • Beta: 0.78; Ross stock is influenced by the S&P 500 and the rest of the retailing industry. Zacks reports its share price was pulled down last August by other retailers reporting poor earnings and sales.

Ownership

Eleven of the gurus followed by GuruFocus have positions in Ross. At year’s end, PRIMECAP Management (Trades, Portfolio) was the biggest among them with more than 13 million shares, giving it a 3.51% piece of the company. Pioneer Investments (Trades, Portfolio) had some 4.5 million shares, while David Rolfe (Trades, Portfolio) had about 1.5 million shares.

Of the guru trades during the fourth quarter, four were buys or adds, while seven were sold out or reduce.

Institutional investors are heavily committed to Ross; they held a 94.25% stake in the company at the previous year-end. Insiders had 0.94%, while shorts had a 1.62% stake.

Outlook

In the news release for the fourth quarter and fiscal 2017, Ross CEO Barbara Rentler said the company had a record fourth quarter, and announced guidance for 2018. That includes:

  • Open 100 new stores.
  • Earnings per share to range between $3.86 and $4.03, up from $3.55 for the 53 weeks in fiscal 2017.
  • Raise the minimum wage in its stores to $11 per hour.
  • Increase the share repurchase authorization to $1.08 billion from $875 million.
  • Push up the dividend by 41%.

The Motley Fool says Ross has a formula for its outstanding, long-term earnings per share growth: 5% to 6% annual growth in square footage; 3% to 5% comparable sales increases; and reducing the share count by 3% to 4% annually. It also argues that as long Ross' margins remain strong, this formula will continue to deliver double-digit returns each year.

A Barron's article notes Amazon.com (NASDAQ:AMZN) can't compete with off-price retailers like Ross and its rival TJX Companies (NYSE:TJX). The prices of the latter two are 20% to 60% below those of Amazon apparel and department stores. That will allow Ross and TJX to expand their current 10% of the broad apparel market.

Rolfe explained his interest in Ross, saying in the second-quarter 2016 report to clients, “We expect Ross to continue investing and expanding its core Ross Stores concepts and DD’s Discount stores across the U.S., as well as eventually enter into international markets, with room to double their existing footprint. Along with a multi-decade history of routinely positive comparable store sales, we expect that Ross’s growing footprint should lead to healthy high-single-digit revenue growth, while margin expansion and buybacks help drive mid-teen EPS growth.”

Conclusion

Who would have expected to find a growth star in bricks and mortar? Yet, that’s what Ross Stores provides to investors who want some acceleration in their portfolios.

Ross does not make it as a pure value play because of its debt (although the debt is not serious when taken in context). At the same time, leverage has worked the way its proponents no doubt wanted: It provided capital for growth without diluting shareholders’ interests and makes many key measures, such as return on equity, look better.

Its moat is strong, giving it a competitive advantage and holding back external pricing pressure. Interestingly, it appears at least somewhat impervious to the predations of online retailers, particularly Amazon.

The margin of safety, while somewhat shallow, is still a margin of safety, something not easy to find among growth stocks.

All things considered, this is a good company at a good price for investors searching for capital appreciation.

The Macpherson model and this article provide an initial scan; investors considering a purchase should do further due diligence.

Disclosure: I do not own shares in any of the companies listed here, and do not expect to buy any in the next 72 hours.

About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995, and in 2010 added options, mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the Unseen Revolution. In Big Macs & Our Pensions: Who Gets McDonald's Profits?, he looks at the ownership of McDonald’s and what that means for middle class retirement income.

In an eclectic career, Robert Abbott was a radio news writer and announcer, a newsletter writer and publisher, a farmer, a telephone operator, and a construction worker. When not working, he has been a busy volunteer, which includes more than a decade of leadership roles at the Airdrie Festival of Lights, one of North America’s leading holiday light displays. He lives in Airdrie, Alberta, Canada.

Visit Robert Abbott's Website


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