Saturday, March 30, 2013

Why I Bought Ross Stores

While reviewing Ross Stores' $ROST recent results I had an eerie sense of déjà vu. It’s not just that it operates in the same sector as its chief rival TJX Companies $TJX, but it seems to have the same approach to understating company guidance. Ross has underperformed its rival, but I think this is potentially a good buying opportunity in a sector set to do well in 2013.

Ross Stores Gives Good Results

Rather like its rival, Ross reported a good Christmas and gave its usual conservative guidance In addition it is (like TJX) doing away with giving monthly sales results. Both companies are investing for growth, but TJX is making more of a play on expanding in Europe; in fact I’ve discussed this issue at more length in this article.

Meanwhile Ross is focused on expanding stores in existing markets and building out two new distribution centers in the next two years while relocating its corporate headquarters. In addition, there are 60 new Ross stores planned for 2013. As such, its capital expenditures are forecast to rise $670 million in 2013 from $424 last year. A busy year!

The chartists among you will note that Ross has underperformed TJX over the last six months, and this is partly a consequence of worse than expected performance in its home goods lines. TJX has been performing well in this category, and other home goods stores have been strong so I think this is probably an issue of Ross’ execution.

Elsewhere Ross was not burdened with the need to aggressively discount or promote during the Christmas season. This is a sure sign that the sector has pricing power because overall consumer spending has been tepid.

Why the Off-Price Retailers Can Continue to Win Out

The retail market is competitive at the best of times, and with an ongoing anemic recovery the sector has seen some vicious changes in market share. The bifurcation in retail, with the high end and bottom end doing relatively well while the mid-market suffers, is now firmly established in the marketplace.

The victims have been the likes of the department store J.C. Penney $JCP, whose habit of missing estimates and downgrading guidance seems to perfectly represent the difficulties in the mid-market. Moreover, its restructuring plan involves focusing on areas like footwear. In other words it can’t offer a ‘trading down’ option without eroding its values.

We can see echoes of this conundrum in the plans of stores like Nordstrom $JWN or brands like Coach $COH. Nordstrom’s plan to deal with the changing environment is to expand its reduced priced Rack stores and invest heavily in e-commerce and mobile technologies. It fully intends to significantly increase revenues from these areas rather than focusing on its full priced stores.

As for Coach, its plan is to diversify its revenue streams by expanding (you guessed it) its footwear ranges and also men’s accessories. Essentially its strong position within the affordable luxury market is leaving it vulnerable to market share erosion from companies like Michael Kors, and with a cautious consumer it will find it hard to react.

My point in mentioning the strategy of these companies is to note that they cannot afford to heavily discount or coupon their way to growth because it will erode the value of their brands. In effect, they are forced to open up new categories, store concepts or sales channels. This is a situation that the off-price retailers do not find themselves in.

Indeed, gross margins and same store sales are holding up just fine for Ross Stores.




Is Ross Stores a Stock to Buy?

In common with TJX, the company has a habit of being conservative with guidance, and the analyst community seems to know this by now. Ross is forecasting 1-2% same store sales growth for the next quarter, and full year overall sales were guided towards 4-5%. However, analysts have the latter number at 6%.

In order to see how conservative Ross tends to be, I have broken out the previous quarter’s guidance and then what it actually achieved.




Can we expect 4-5% same store sales growth for the next quarter instead of the 1-2% guided to? We shall see.

In any case, I believe the stock is good value. Analysts have double digit earnings growth forecast for the next few years. Its underlying cash flow is strong, and an EV/EBITDA evaluation of 8.7x is not expensive at all. I will look to pick some up.