Can This Retailer Keep Rising in 2013?
Leo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Ross Stores (NASDAQ: ROST), an apparel and home fashion retailer that specializes in selling off-season brand names at steep discounts, has been one of the strongest growth stocks over the past decade, rising 550% since 2003. However, the stock stumbled recently, after the Pleasanton, Calif.-based company posted negative February same-store sales growth that missed already downbeat analyst projections. This rare miss shook up investors who had grown accustomed to its relative strength in strained economic times. Are Ross’ best days behind it, as the country comes to terms with a potentially crippling payroll tax hike, or are bearish concerns overblown?
The Big Picture
To better understand Ross’ growth prospects, we must first understand the bigger picture. In the United States, the biggest macro factor causing concern among apparel retailers is the much maligned payroll tax hike.
In 2013, an average American worker who earns $50,000 a year will pay roughly $1,000 more in taxes, as a result of the Social Security payroll tax rising two percentage points. Research from the nonpartisan Tax Policy Center indicates that workers earning $30,000 to $200,000 annually will face far higher reductions to their income that higher paid ones.
Lower disposable income does not paint a pleasant picture for retail stocks in 2013. Many investors’ initial response was to invest in discount retailers, such as Ross, The TJX Companies (NYSE: TJX), Target (NYSE: TGT) and Wal-Mart (NYSE: WMT), since these seemed the most likely to profit as people started to curb their spending habits.
Although that investment thesis is solid in theory, Wal-Mart’s disappointing fourth quarter earnings showed that not even the cheapest retailers were immune from the payroll tax hike.
Wider rather than deeper
So where does that leave Ross? Can it succeed where even mighty Wal-Mart failed?
Ross Stores is an off-price retailer that sells overstock brand names at discount prices. It operates more than 1,200 stores across the United States, making it the third largest off-price retailer in the country after T.J. Maxx and Marshalls - which are both owned by The TJX Companies.
Ross’ business model is slightly different from T.J. Maxx, as it purchases a large amount of "packaway" inventory at a discount at the end of the season. This inventory is often stored for several quarters prior to selling, as opposed to constant purchases throughout the year. This strategy helps the company maintain its pricing and inventory better, and offers stronger control over its full-year outlook.
Ross also focuses on offering a broad variety of branded overstock, without concentrating on a particular group of products. Therefore, despite offering branded products that may not be the newest on the market, its wide variety of products constantly feels fresh to regular shoppers - a tactic the company calls “wider rather than deeper”.
Ross’ larger competitors, such as Target, H&M, Kohl’s and Burlington Coat Factory either offer a more limited selection of brands, or their products are higher priced.
Ross also has some ambitious growth plans. The company intends to more than double its stores by the end of the decade, with a target of 2,500 stores - to catch up with TJX, which operates 2,900 stores.
Optimism, skepticism, pessimism
Thanks to these positive micro catalysts, shares of Ross were up roughly 8% over the past twelve months, and 67% over the past two years. However, a nasty plunge on March 7 erased most of the year’s gains after a lackluster February sales report cast serious doubts on the company’s growth potential in 2013.
This simple chart illustrates the downward trend in Ross’ same-store sales.
Source: Ross Stores Sales Releases
Analysts surveyed by Thomson Reuters were expecting a modest 1.1% increase for February. What’s more, February is traditionally a strong month for Ross, which posted 9% same-store sales growth a year earlier.
While those numbers look to get progressively worse as the year progresses, Ross CEO Michael Balmuth stated, “We believe the slight decline in February same store sales was mainly due to the delay in income tax refunds.”
Looking forward, Balmuth offered these same-store sales figures for March and April.
Source: Ross Stores Sales Release
Balmuth believes sales will pick up around Easter, which falls on March 31 this year. However, its March numbers are too bleak to ignore - especially compared to the prior year’s 10% growth - which makes me wonder if Ross can truly hit those sales targets for April.
The Foolish Fundamentals
On a fundamental basis, how does Ross fare against TJX, Target and Wal-Mart?
Source: Yahoo Finance, 3/8/2013
While superstores Target and Wal-Mart are more fundamentally undervalued, Ross and TJX have performed far better in the past, as evidenced by their return on equity ratios. Ross also has the strongest margins of the bunch, as a result of its aforementioned “packaway” strategy of controlling costs. Ross’ low debt levels will make its ambitious expansion plans over the next decade an achievable goal.
However, once we look at Ross’ top and bottom line growth over the past five years, the long term strength of this stock becomes glaringly evident.
Revenue grew 52.89% and earnings rose 227.7% during this period, outperforming all three competitors. Looking ahead, analysts expect Ross to grow its earnings 23% for fiscal 2013. In 2014, earnings growth is expected to slow slightly to 11%.
Earnings growth outpacing revenue growth is a clear indicator of improving margins, which are confirmed in this last chart.
The Foolish Bottom Line
Ross’ strategy is as simple as its tagline, “Dress of Less.” Even in leaner times, Americans still love brand name items, and that constant fact will drive the company’s long-term growth. Even though the payroll tax may cause a decline in lower-income shoppers, most analysts believe that middle and upper middle class shoppers will replace those lost customers as those dreaded reductions to discretionary income kick in. Although the company is about to hit a few speed bumps in 2013, its long-term growth is still intact - making it a solid, safe investment for the more conservative growth investor.
Leo Sun has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!