After a strong share price move leading into its earnings, off-price retailer Ross Stores (NASDAQ: ROST ) disappointed investors with its quarterly results and guidance. Meanwhile, its main rival TJX (NYSE: TJX ) cheered the market by beating estimates and raising guidance. It's time to look at Ross Stores and assess whether or not the recent decline is a buying opportunity. In addition, looking at trends in discretionary spending at Dollar Tree (NASDAQ: DLTR ) , Dollar General (NYSE: DG ) , and Family Dollar (NYSE: FDO ) will help guide Foolish investors towards a clearer picture of conditions at the lower end of retail.
Ross Stores breaks a trend
Some stocks can develop a logic all of their own. The market has gotten used to TJX and Ross beating their respective internal guidance. Subsequently, when they fail to do so it's regarded as a disappointment. While TJX managed to generate 5% same-store sales growth (its guidance was for 2%-3%) in the quarter, Ross's same-store sales came in lower than the mid-point of its guidance for the first time in a long while. Moreover, Ross' fourth-quarter guidance of 1%-2% same-store sales growth was uninspiring.
It gets worse. In discussing the business environment on the conference call, Ross' management noted a number of reasons why the company was taking a more cautious approach to the rest of the year.
retailers are planning to open earlier than prior years on Thanksgiving Day... ...6 fewer shopping days in 2013 between Thanksgiving and Christmas... ...retailers have reported disappointing results over the past few quarters... ...will create the most intensely competitive and promotional holiday selling period in recent years.
Moreover, Ross' traffic was flat in the quarter, with an increase in basket size driving sales growth. This could be a concern, because in a shorter selling season, traffic is going to be even more important than usual.
Frankly, Foolish investors should look out for more variability in the outlook statements from the retail sector this Christmas. Companies can only report what they are seeing, and spending trends are likely to change dramatically because of the shortened selling season.
While Ross is gloomy, what is the rest of the industry saying?
What Dollar General, Dollar Tree, and Family Dollar said
TJX raised its guidance, but it was noticeable that it did not adjust the guidance for its fourth quarter, which indicates some caution. Turning to the dollar stores, they have been battling all year to try to increase their discretionary-product sales. Such products tend to come with higher margins than consumables, and they are a good indication of a return to spending power at the lower end of the market.
Dollar Tree's relative performance with discretionary products has been better than the other dollar stores this year. Indeed, on its third-quarter conference call management stated "So what you saw beginning in Q2 this year was a little bit of a shift, with the non-consumables growing a bit faster than the consumables." However, it's not entirely clear whether this is a macro effect or a response to Dollar Tree rolling out relatively fewer consumable products than it has in previous years.
The picture wasn't any clearer with Dollar General in its third quarter. In response to an analyst's question on "encouraging" discretionary trends, CEO Richard Dreiling replied that he thought the "trade-down customer is getting more comfortable with the quality of the products we're putting out there" and "I think we're doing a much better job on the merchandising selection here." Finally, on its fourth-quarter conference call, Family Dollar argued that there was...
...stabilization in our discretionary businesses and we delivered our best comp performance of the year in these higher-margin categories. We remain cautious on the outlook for our customer, but we do believe that we are turning the corner in several key discretionary businesses.
All three are cautious on the consumer, but frankly, none of them reported deterioration with their discretionary products. It's fair to summarize their statements as mildly positive.
Time to buy Ross Stores?
With that said, is it time to buy into the weakness in Ross Stores with the anticipation that it will beat its cautious guidance?
The dollar stores aren't saying overtly negative things on discretionary spending, and Ross Stores's third-quarter numbers weren't that bad. Its guidance isn't great, but 1%-2% same-store sales growth is what it projected for three of the last four quarters.
Furthermore, on the evidence of the trailing figures collated below, there is a good case for buying in. Note that adjusted free-cash flow is simply trailing operating cash flow minus depreciation. This is a more useful measure of underlying cash-flow generation because all of these companies are in an expansionary phase.
|($ in millions)||Dollar Tree||Family Dollar||Dollar Tree||TJX||Ross Stores|
|Operating Cash Flow||731||472||1,242||2,599||1108|
|Adjusted Free-Cash Flow||544||248||922||2,055||911|
|Adj FCF as % Revenue||6.9||2.4||5.4||7.5||
|Adj FCF as % Enterprise Value||4.5||3.1||4.3||4.6||5.8|
|EPS Growth Rate %||10.7||10.2||15.7||13.6||12.3|
A company that generates 5.8% of its enterprise value (market cap plus debt) in free-cash flow with double-digit growth prospects is usually attractive. Provided that Ross can at least hit its holiday-season guidance, the stock looks like a good value.
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