Ross Stores: Gift That Keeps On Giving

Nov. 18, 2016 8:01 PM ETROST
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Joe Papa's Blog
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Contributor Since 2016

I am a value conscious investor looking for bargains.


1) Price is what you pay, value is what you get

2) Success in investing is limiting losses when you're wrong, and maximizing gains when you're right

3) Start with business model.  Margins reflect value add a company's products bring to the market place.  Does the Gross Margin and the Product match?  High GMs accompany differentiated products with limited competition that do not compete on price.  Low GMs accompany undifferentiated products that compete on price, CAPEX spend, cyclicality.

4) How is the business financed?  Be wary of companies with a lot of debt.  Great businesses do not require huge debt to generate high returns on equity.  There is no achievement in generating high ROEs by levering up like banks, leasing businesses (car rental, equipment rental, aircraft rental).  ROA should be telling here.

4) A company's value changes because the NPV of future profits changes.  NPV of future profits is a function of changes in revenues, gross margins, OPEX, leverage, taxation.  A company's value appreciates when the NPV of profits goes up due to revenue growth, GM expansion, OPEX reduction, leverage (refinancing) / tax (change of domicile) reduction.

5) Markets look forward.  Bottoms coincide with maximum pessimism while tops coincide with maximum euphoria.  

6) A stock is not undervalued because it is cheap and it is not overvalued because it is expensive (based on traditional valuation metrics).  Similarly, a stock is not undervalued because it has gone down a lot or overvalued because it has gone up a lot.

7) Look at market cap when valuing companies.  Don't be overly influenced by management projections, analyst reports, share buybacks, cash on B/S, price movements, other people in the stock. 

8) Companies with significant debt can go bankrupt.  Cash burn typically determines if they go bankrupt before the cycle (for their industry or the economy) turns.

9) Undervalued stocks can get cheaper, overvalued stocks can get more expensive. 

10) Keep emotion out of investing.  You will be wrong.  Unpredictable things will happen.  Stay vigilant to anger, anxiety, exuberance.  Stay vigilant to thesis creep.

11) Leverage will kill you sooner or later.  Companies have large operating and financial leverage. 

12) Have a thesis.  If the thesis plays out, stay with it.  If it doesn't exit.  Always have a thesis.

13) Understand the business you are invested in.  It's valuation and what can go wrong.  Know the business inside out.

13) Don't trade. 

14) Diversify.  There are many good ideas in the market.  Don't put your eggs in one basket.

15) Failing businesses rarely turnaround.

Since IPO, Ross Stores has generated very attractive returns for investors. It's gone up seven fold since 2009 and now sports a juicy market cap of $27b. Of course, all this is hindsight. But its instructive to note that you could have bought Ross Stores any time since the IPO and done very well. In fact, you can still buy Ross Stores. The returns will almost certainly not be as good going forward. But the run is not over, based at least on the latest numbers.

Here is the company description:

"Ross Stores, Inc. is an off-price retailer of name brand and designer apparel, accessories, footwear, and home fashions for the entire family. The Company and its subsidiaries operate two brands of off-price retail apparel and home fashion stores: Ross Dress for Less (Ross) and dd's DISCOUNTS. Ross is an off-price apparel and home fashion chain in the United States, with approximately 1,274 locations in over 34 states, the District of Columbia and Guam. Ross' target customers are primarily from middle income households. The Company operates approximately 172 dd's DISCOUNTS stores in over 15 states. Both Ross and dd's DISCOUNTS brands target value-conscious women and men between the ages of 18 and 54. The Company owns and operates approximately six distribution processing facilities, including three in California, one in Pennsylvania, and two in South Carolina."

Now let's look at the results for the quarter:

SSS were up a whopping 7% YoY. Revenues grew 15%. Operating margin was up to 12.6%. There's a buy back in place and business is humming. Sales guidance calls for a SSS increase of 1-2% over last year's 4% increase. EPS is projected to be up 11-12% YoY. Not bad.

Ross opened 77 new stores over the last year. Growth continues. From the transcript of the quarterly call.

"As planned, we completed our 2016 store opening program during the third quarter, with the addition of 25 new Ross and nine dd's DISCOUNTS. We expect to end fiscal 2016 with 1,338 Ross and 192 dd's DISCOUNTS, an increase of 84 locations for the year."

Now let's consider Ross' valuation. The market cap is $23b on sales of 12b and the forward P/E is closer to 23. So it isn't cheap. But the valuation is well deserved. Business is humming and there is little evidence that (despite the poor retailing environment) we should sell Ross Stores. Granted returns will not be as good going forward simply because of the larger size, and there's a chance that growth slows and the stock re-rates, but this has been a huge winner and its worth keeping around in the portfolio until there are signs the growth story is over.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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