Ross Stores (ROST) is the latest result from my defensive screen setup on GuruFocus. It is currently the only stock that resulted through the screen. The previous result was PetSmart (PETM) at the beginning of May when the stock was trading at $66.85. The stock soon dropped to a low of $55 on May 27, but has since rebounded after activist positions were disclosed by Jana Partners (9.9% of outstanding shares) and Longview Asset Management (9.0% of outstanding shares). The stock is now trading at $70.10.
The criteria for the screen are:
Business Predictability: Minimum 5 out of 5 stars
Financial Strength: Minimum 7 out of 10
Warning Signs: Maximum of 0
Altman Z Score: Minimum of 2.99
P/E: Maximum of 17
Beta: Maximum of 1.0
Dividend Yield: Minimum of 0.10%
High business predictability indicates that a company has a strong history of producing operating profits. The companies have not had an operating loss in the past 10 years. 5-star stocks have had an average annual return of 12.1 percent over the past 10 years. Only 3 percent have had a loss if held for the full 10 years. The criteria for warning signs can be related to both the financial statements and issues concerning the characteristics of the stock. I chose to screen for a P/E of 17 or less in order to find stocks that were not trading with higher valuations than the S&P 500. Finding stocks with beta of less than 1 will result in companies that are less volatile than the S&P 500. The dividend yield will help provide support for the stock if the overall markets are in a downturn. Let’s take a look at Ross Stores to see how it meets the criteria of a defensive stock.
Company Background:
Ross Dress for Less is the largest off-price apparel and home fashion chain in the United States with 1,172 stores in 33 states, the District of Columbia, and Guam. TJX Companies (TJX) has more stores overall, but they are split between T.J. Maxx and Marshalls. Ross Stores also operates 137 dd’s Discount stores in 10 states. The “dd” stands for deep discounts. From 1957 to 1982, Ross operated as a small, family-oriented junior department store chain in the San Francisco Bay Area. In 1982, The company’s founder, Stuart Moldaw, and a group of investors acquired the six-store chain and converted the location to the current off-price format. The company went public with its IPO in 1985 and has been expanding into its current form.
Ross operates in the big, box store format that has been struggling lately due to online competition. What helps Ross is that their stores already have the bargains that people are shopping for online. Their stores offer first-quality, in-season, name brand designer apparel, accessories, footwear, and home fashion for the entire family at everyday savings of 20 to 60 percent off department and specialty store regular prices. dd’s Discounts offers everyday savings of 20 to 70 percent off moderate department and discount store regular prices.
| Merchandise Mix | |
| Ladies | 29% |
| Home, Bed, and Bath | 24% |
| Men's | 13% |
| Accessories | 13% |
| Shoes | 13% |
| Children's | 8% |
About 75-80 percent of the customers are female and shopping for themselves or other family members. Brands are important to the average customer, they enjoy shopping for bargains and the core customer averages about three visits per month. People are attracted to the store for the purpose of wanting to find a bargain and also if they need a bargain.
Financial Strength:
The company is very strong financially with a Financial Strength rating of 9/10. Ross currently has $596 million in cash and $150 million in long-term debt. Cash has been increasing at a rate of 19.96 percent per year for the past five years while the long-term debt has remained constant at $150 million since 2007. The company also has enough operating income to cover their interest expense 5,309 times. The Altman Z-Score is 8.17 indicating a very safe level of debt.
Ross Stores has a high Profitability & Growth rating of 8/10. It has industry leading margins with an operating margin of 13.13 percent and net margin of 8.18 percent. Net margins have been increasing every year for at least the past ten years and have more than doubled over the time period. The apparel stores industry mean for net margin is 3.54 percent, less than half of Ross’ margin. Revenues have also been consistently increasing every year for the past ten years. Revenue per share has been increasing at a rate of 13.74 percent per year over the past five years. The company was able to increase sales by 9 percent year-over-year for the first quarter of 2014 even in a negative growth environment where the U.S. GDP dropped 2.9 percent.
ROST data by GuruFocus.com
Ross has an excellent track record of enhancing shareholder value through stock buybacks and cash dividends. It has been buying back shares every year since 1993, even during the recent Great Recession. The latest buyback program was approved in January of 2013 to repurchase $1.1 billion of stock over the 2-year period of 2013-2014. $550 million of stock was repurchased in 2013, and the remaining $550 million is expected to be repurchased by the end of this year. The dividend is currently $0.20 per share quarterly, giving it a yield of 1.20 percent. This year was the 20th consecutive annual increase. The increase for this year was 18 percent on top of last year’s increase of 21 percent.
Management:
In June, the Chairman of the Board since 1993, Norman Ferber, retired, and senior management was shifted upward to fill in the empty positions. Norman Ferber has been helping the company grow since the 1980s. He will remain a director and continue to actively consult with senior management on critical operating and strategic initiatives. Michael Balmuth has stepped up to take his place as Chairman. He was the Vice Chairman and CEO dating back to 1996 and will provide stability to the management that will help the company’s continued success. Barbara Rentler, the former President and Chief Marketing Officer of Ross Dress for Less, has moved up to be the new CEO. The effective succession planning within Ross Stores will help the company continue on its path of profitability and growth.
Valuation:
Ross Stores is selling at a discount in relation to its long-term median P/E ratios. The 10-year median P/E is 17.6, and the 5-year median P/E is 16.8. The current P/E for the company is 16 and analysts are projecting a forward P/E of 13.54. At its 10-year median P/E the stock would be priced at $69.62 and priced at $66.45 if valued in line with its 5-year median P/E. The stock is currently trading at $63.16.
Using CAPM, Ross’ low beta of 0.71 gives it a required return of 8.34 percent. The company’s high business predictability helps support the low volatility reading of the stock. Using a discount rate of 8.34 percent with the GuruFocus DCF Calculator indicates that Ross Stores only needs to grow earnings at a rate of 7.33 percent of justify its current price. Earnings have grown at annual rates of 25.9 percent for the past 10 years, 22.10 percent over the past 5 years, and 7.6 percent over the past year. The company can likely grow at a rate of 10 percent in a positive GDP environment. A growth rate of 10 percent gives Ross Stores a fair value of $78.55, making it undervalued with a margin of safety of 17 percent.
Risks:
The company is subject to the overall growth of the economy. Slowdowns in the economy would likely decrease same-store sales and slow down the company’s expansion plans. Ross obtained a 1 percent increase in same-stores sales while the GDP fell 2.9 percent in the first quarter of 2014. It would be difficult for the company to maintain positive same-store sales growth in a prolonged recession. Although, Ross Stores was able to increase overall sales in the Great Recession. Another risk that is affecting the big, box store model is the increase in online purchases. Ross’ discounts and the desire of customers to hunt for a bargain have helped the company maintain its sales growth while others have been struggling.
As far as the stock movement itself, the stock is currently in a downward trend. It is down 12 percent year-to-date and down 22.78 percent from its 52-week high of $81.99 on 11/18/2013. The 3 percent drop today is likely due to a downgrade from Sterne Agee. A sign that the stock has ended its downward trend could be if it breaks above the 50-day moving average. Since the beginning of June, the stock has made three attempts, but failed to break above the moving average.
Outlook:
The 22.78 percent drop of Ross Stores is too much given its strong fundamentals. The stock will likely drop a little further throughout the next month due to its overall downward trend. In the long run, Ross Stores is an excellent value. PetSmart was the only other stock to result from the screen that was used to find Ross Stores, and it has gained the attention of activist value investors. TJX Companies has similar readings across the board when it comes to profitability and growth. Ross has lower P/E of 16 compared to TJX’s P/E of 17.87. Ross’ lower market cap of $13.39 billion can draw more attention from an activist than TJX’s much larger market cap of 37.07 billion. Ross Stores also has great growth opportunities within the United States. It is only in 33 states and has a total of 1,309 locations. The company states that its long-term growth potential is to have 2,500 stores in the U.S.
Guru Trades:
The stock is currently held by 14 investing gurus that we follow. PRIMECAP Management is the largest holder with 6,496,440 shares, representing 3.1 percent of the outstanding shares.
The disclosures of portfolios at the end of the first quarter revealed five buys and four sells by the gurus. Diamond Hill Capital and RS Investment Management added new positions and Joel Greenblatt and Jim Simons sold out of their positions. Now that the second quarter is over, the investing gurus have 45 days from the end of the quarter to file their 13Fs revealing their long equity positions. You can check with GuruFocus to monitor any changes in the gurus’ portfolios.
