- ROST reported earnings on Tuesday and the stock is selling off.
- Q4 results were strong but guidance was a bit underwhelming.
- I think ROST is still very reasonably priced, given its potential for further earnings and dividend growth going forward.
Ross Stores (NASDAQ:ROST) has been a tremendous performer over the past few years. The off-price treasure hunt retail experience is a proven winner and along with TJX (TJX), ROST has made a nice living off of the concept. Execution has been key as comps and margins continue to rise and the share price has reflected those realities. The company’s Q4 report was tremendous and earnings estimates continue to rise, but shares have been unable to reclaim the highs set in January. However, even though the stock isn’t cheap, it is reasonably priced here and given that ROST is a segment leader, I think it is still worth a look on the long side.
Multiple levers for sales growth
Sales for the fourth quarter were up a whopping 16% as contributions came from a higher number of stores, an extra week and comp sales of 5%. ROST’s growth profile is one of the things that attracted me to the stock a couple of years ago and nothing has changed; we are still seeing mid-single digit unit growth and comps continue to impress as this Q4’s result stacked on top of a 4% gain last year. The same story is true for the full year as a 4% comp stacked on a 4% comp for the prior year as well. ROST’s ability to continue to build upon prior success has honestly gone on longer than it thought it would, and that really speaks to just how well the model is working.
Margin expansion continues
ROST also continued its impressive streak of margin growth as operating margins came in at 14.6%, a 95bps improvement over last year’s Q4. The extra week played a part, but strong merchandise margin and leverage on expenses helped as well. Constant comp sales increases will afford a retailer the ability to leverage down costs and that’s what we’ve seen from ROST; but in addition, strong merchandise margin is what I’m excited about. ROST’s model is built upon low pricing to attract value shoppers and it obviously works, but being able to boost margins in a low-price environment the way ROST has really sets it apart. This is an extremely well-managed company.
Management called the company’s guidance for this year “prudent,” and to me, that means there may be some underpromising potentially going on; that's an unusual term for a management team to use. Comps are expected to grow 1% to 2% on top of the past three years of 4% gains annually, meaning ROST is essentially guiding for a significant slowdown in revenue growth. New stores will help as well as ROST is going to open 100 new stores, which should be good for about 6% total unit growth. It is curious to me, then, that analysts have ROST at just 4% total sales growth this year when it should be able to achieve that based simply upon unit growth. When you add in the guided comp number, I think total sales growth will be more like 6% than 4%. As I said, I also think ROST may be setting us up for a low bar it can step over because its comps have been so good for so long; I’m hesitant to say that comp growth is just going to stop.
One potential area of concern is margins, however, because should the slowdown in comps occur, that may impact ROST’s ability to continue to leverage down costs. ROST is raising its minimum wage to $11 and while that’s a noble thing to do, it is also expensive. ROST is taking the opportunity to spend some of its tax savings on its associates and that may crimp its margin profile this year. The extent to which that may happen remains to be seen, but as of now, it appears to me that guidance is a bit weaker than expected overall. I'll be watching SG&A spending with a keen eye this year to see how this plays out.
Capital returns remain a priority
ROST did boost its buyback authorization to $1.075B – a number which is oddly specific – and that should help reduce the float by roughly 3% this year depending upon what the stock price does. That’s a nice tailwind for EPS, and ROST also boosted its dividend by 41% to 22.5 cents quarterly. That’s good for a forward yield of just over 1%, and while that’s certainly nothing to get excited about, the potential for ROST to continue to grow the dividend down the road is enormous. The current yield is only a small fraction of earnings, and the recent emphasis from management on the yield is encouraging; it would appear ROST is set up to become a very nice dividend growth story in the coming years. That’s not a primary reason to own the shares just yet, but it certainly doesn’t hurt.
A reasonable price for a segment leader
At 19 times this year’s earnings, ROST looks reasonably priced to me. As I mentioned, ROST is a segment leader and thus, it doesn’t really get to the point where it is cheap. While 19 times earnings is still a bit higher than perhaps value investors would like, longer-term EPS growth forecasts are still in the low double-digit range and that’s certainly good enough to justify the current valuation. The potential for dividend growth is a big positive as well, and don’t forget about the buyback providing a constant bid under the stock going forward. While guidance wasn’t what I was hoping for, I do think there’s some room for upside this year based upon the factors I mentioned; so I see this post-earnings dip as a chance to buy ROST. The factors that are allowing ROST to perform so well aren’t going anywhere, so neither am I.
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This article was written by
Josh Arnold has been covering financial markets for a decade, utilizing a combination of technical and fundamental analysis to identify potential winners early on in their growth cycles. Josh's focus is mainly on growth stocks. His goal is efficient and profitable use of capital, which overly rigid buy-and-hold strategies do not allow.Josh is the leader of the investing group Timely Trader where he focuses on limiting risk and maximizing potential reward. Features of Timely Trader include: real-time alerts, a model portfolio, technical charts, sentiment indicators, and sector analysis to find the best trading opportunities. Learn more.
Analyst’s Disclosure: I am/we are long ROST. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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