Does Ross Stores Have Room to Grow?

More analysts cover discount department store Ross Stores (Nasdaq: ROST) than many of its peers, yet the company resembles a business that is underfollowed and neglected by the market—two indicators of a stock prone to pricing inefficiency.

For one thing, Ross Stores outperforms its rivals across multiple margin tiers and leads the industry in return on equity. The company has grown sales nearly 20% from the fiscal year ending in 2012 to 2014, and operating cash flow has grown even faster. The most recent quarter was neither exciting nor particularly soft, considering market conditions, but this company holds some qualities on a risk averse, long-term investor's checklist.

Put aside the recent earnings report, which included a same-store sales bump of 1% during a period of poor apparel sales performance across the industry, and look at the longer term story at Ross.

The company's off-price business model has not only weathered the tepid consumer spending environment, but thrived in it. Ross Stores has increased its top and bottom line figures for the past three years, driven by new stores and consistently positive comparable sales figures. The expansion is proving to be a great use of capital, as Ross' trailing twelve-month return on assets is above the 20% mark. For comparison, JC Penney continues to earn a negative ROA. The only comparable business in Ross Stores' league is TJX Companies, the parent of TJ Maxx stores.

For the full year, Ross intends to open nearly 100 new locations, comprised of 75 namesake department stores and 20 dd's Discounts.

Ross' merchandising and marketing strategy is refreshing from the usual suspects in that its relatively staid compared to the omni-channel sprint and scurry to stay relevant movements.

Why it's appealing
Despite its high margins and very attractive capex strategy, Ross trades at an average valuation. At 14.5 times forward expected earnings, the company is right in line with aforementioned TJX, and a slight discount to closeout retailer Big Lots at 15 times earnings. On an EV/EBITDA basis, Ross' nearly debt-free balance sheet shines bright, giving it a trailing 8.8 times multiple, compared to TJX's more than 9.6 times.

When looking at the peer group, the only business that looks more immediately appealing is Dillard's, a regional player with a dirt cheap EV/EBITDA (6.2 times) and a similar record of steady, successful merchandising and marketing strategy. Dillard's holds a considerably heavier debt profile and has not quite achieved the heights that Ross has in return on equity and assets.

At these levels, Ross isn't particularly cheap, but the company does appear to be in a great position going forward. It's ability to maintain growth (albeit at a slower pace) and gain market share during a downtime in apparel spending, coupled with fantastic margins, should bode well for the market's rebound in the coming periods. Then, the working strategies should take on a higher profile and impress investors with refueled growth prospects.


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Michael Lewis

Michael is a value-oriented investment analyst with a specific interest in retail and media businesses. Before coming to the Fool, Michael worked with private investment funds focusing on deep value and special situations. Currently living in the media capital of the world--Los Angeles, California.

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