When I first purchased the stock in January (at $12.50 a share), my investment thesis was that this was a solid, well-managed company in a very difficult sector. Given its depressed price (about 7x trailing EPS), I figured that there was very little downside, and that if any good news emerged the stock could quickly double. I'll take that bet all day long if I think there's a decent chance of good news emerging.
At first, I felt like a genius, as the company announced a big share buyback, and monthly same-store sales increased a robust 7%, 8%, 3%, and 11% from January to April. The stock responded, nearly doubling to a peak above $24 a share. But things have been all downhill for Ross since then, as same-store sales in May through August were +3%, -1%, -2%, and -3%, and -- as I discussed in my column two weeks ago -- debt has risen and free cash flow has tanked. Not surprisingly, the stock has fallen back to just above where I first bought it, closing Friday at $14.25.
In retrospect, of course, I should have sold earlier, but the company appeared to have the wind at its back. Also, I always try to avoid incurring capital gains taxes, especially short-term ones, which can wipe out nearly 50% of your gains if you live in a high-tax area like New York City.
Ross' recent woes may be fully reflected in the stock price, so it doesn't necessarily make sense to sell the stock now. If the company is simply being buffeted by a slowdown in consumer spending and increased competition from department stores, as the company claims, it might be a good bet for a turnaround. But I'm not willing to make this bet unless I think Ross is executing well, because this is an industry where bad execution can be fatal.
Readers Rip Ross
After hearing from two dozen readers (thank you!), I have come to believe that Ross' execution -- at least in recent months -- has been mediocre at best and possibly far worse. This is the primary reason I am selling.
In last week's column, I printed three e-mails from readers and invited others to share their comments, both positive and negative. Twenty-one more people replied. I subjectively rated all 24 e-mails on a scale of 1-5, with a 1 being very positive about Ross and a 5 being very negative. Here were the results:
Highly positive 2 (8.3%) Somewhat positive 1 (4.2%) Neutral 2 (8.3%) Somewhat negative 4 (16.7%) Highly negative 15 (62.5%)
Ouch! Politicians with negatives that high are soon voted out of office. Companies (non-monopolistic ones anyway) with negatives that remain so high are often out of business in short order.
As I noted in last week's column, "Ross doesn't try to be a full-service store (that's how it keeps its prices low)," so fairly high negatives don't surprise me. But it's very disturbing to me as a Ross shareholder to hear from formerly loyal Ross customers who no longer shop there because of a significant decline in the stores. I also received troubling reports from a former Ross executive and the husband of a Ross store senior manager. Here are some short excerpts from some of the e-mails (to avoid charges of bias, the few positive ones are first):
"My wife and I have, in general, had positive experiences at Ross. We have had the perspective of regularly visiting stores in several different locations.... In most cases, the stores are clean, well-stocked, and busy. My wife prefers Ross to such stores as TJ Maxx and Marshalls. She has felt that Ross had the better selection, with less 'junk' mixed in."
"My wife and I are frequent shoppers at the West Los Angeles stores and found them to have abundant inventories of designer clothes and shoes. The help at the stores were efficient and quick. The store was full of buyers with their carts full of merchandise. The only complaint we have is waiting too long because of the long lines."
"I observed many of the same things as your readers but came to a somewhat different conclusion about what I saw. In fact I came home thinking seriously about buying some Ross stock. The first store we came to was well-stocked but very busy with people buying large numbers of items at what I perceived to be great prices. Two days later at the same store I observed many empty racks as a result of this furious buying and at the back of the store full racks of clothing waiting to be put out for sale."
This e-mail, from the husband of a Ross store senior manager, presents both the best and the worst at Ross:
"My wife's store in Oklahoma is constantly having great difficulty getting the huge inflow of stock out of the stock room onto the floor.... [The] store is doing great!... [However] last summer, I was in a Ross store in the Denver area and the store had been trashed so badly by the customers that some aisles were impassable! I have never seen any store in that type of disarray unless it had been struck by a tornado or hurricane!... I believe that Ross has a tremendous number of things going right for them but they better figure out what is really going on at the store level, correct the negatives, and accentuate the positives."
But most of the e-mails were like these:
"I went to my local Phoenix-area Ross, after not shopping there for over a year, and was shocked by the complete disarray of items on shelves, broken, left on the floor, and the unkempt, dirty environment. Trash all over the floor, filthy carpets, clothing with stains and tears, no merchandising or organization whatsoever.... There is a serious problem going on here. In the past, the store has been clean, organized, and well-stocked, with adequate staff, and since reading your other reader mail, I realize it is a company-wide problem, not just my local store. What is going on, I don't know, but I don't foresee good things happening to this chain."
"Over the years I have been a steady shopper with Ross. In the last year, whenever my daughters and I went to Ross, we'd come home nearly empty-handed. We'd spent hours combing through racks, ready to spend hundreds of dollars. Nothing. Each time we go things are worse. I think they lost focus on their mission (selling clothes) and lost some excellent buyers. Having watched this downhill trend for a full year, I suspect that it's too late to turn it around. Once you alienate a strong spending customer like me -- the type who keeps their friends informed on sales, great buys, etc. -- you can't get us back. We're bargain hunting now with the competitors."
From a former Ross executive:
"They have a long road ahead of them trying to figure out how to reduce expenses that have already been cut to the bone. They have many stores that need remodeling, payroll is too thin (have you seen any employees on the sales floor or enough to help ring registers?), and with all this going on how are they going to increase sales to offset the additional cost of remodels and store payroll? Their expenses were cut during a time of high single- and double-digit sales growth which was great for the shareholder (the stock split twice), but not a good strategy for the long-term benefit of the company.... If you look back, their excuse for softer-than-expected sales is a continual pressure from the department stores being more promotional. Have you shopped their stores lately? They need to focus on operational issues within their four walls. Unfortunately, they can't reduce their store operating expenses due to prior management's tight (too tight) controls. So, look forward to tough times for this company as they try to determine how to improve store standards, compete with a highly competitive retail environment, and improve store sales with less inventory and less help."
I have published the full text (with minor editing) of all 21 e-mails I received this week for a number of reasons. First, I think they provide invaluable information for anyone deciding whether to buy, hold, or sell the stock. Second, I want Ross to turn itself around, so I hope that the company's management team reads them. I used to be a consultant, and I know many companies that have paid hundreds of thousands of dollars for the kind of valuable information and recommendations found in these e-mails. Finally, I don't want anyone accusing me (as happened after last week's column) of trying to smear the company by selectively quoting from only the negative e-mails. I encourage you to read them all for yourself and draw your own conclusions.
Next week, I will conclude with some thoughts and lessons, and a proposal to evaluate some additional companies together.
-- Whitney Tilson
Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com. To read his previous guest columns in the Boring Port and other writings, click here.