Decatur Capital Management, with a current market value of portfolio at $805 million, has meaningfully increased its stake in Ross Stores (ROST, Financial), according to the company’s latest filing available in Guru Focus and in Guru Focus Real Time Picks. As compared to 53,500 shares held by Decatur as of March 2015, the stake has now increased to 487,700 shares as of June 2015. In this article, I will discuss the factors that I believe are bullish for Ross Stores in the long-term.
Ross Stores operates off-price retail apparel and home fashion stores under the Ross Dress for Less and dd’s DISCOUNTS brand names in the United States. As of June 2015, the company had 1,242 stores in 33 districts in the United States and 157 dd’s Discounts in 15 states. The company’s revenue has steadily increased from $7.9 billion in FY10 to $11.0 billion as of FY14. During the same period, the company’s EPS has expanded from $1.16 to $2.21.
The first reason to be bullish on Ross Stores is the growth potential that the company holds in the coming years. While the company is currently operating just 1,399 stores in 33 states, the company estimates a potential of 2,500 stores with Ross stores likely to have a potential of 2,000 stores and dd’s Discounts having a potential of 500 stores. Therefore, the number of stores can potentially double from current levels and I believe that this growth is possible considering the following factors:
First, the economic environment in the U.S. has been challenging in the last five years and Ross Stores has continued to grow in this environment. The reason is the ability to offer bargains at “Dress for Less” stores. With slow wages growth hurting consumers, bargains increase demand for the company’s stores.
Second, a target of 500 dd’s Discount stores is likely to boost growth as it is targeted towards consumers that have more moderate income levels than “Dress for Less” stores. The company is effectively targeting the lower income group as well as the middle income group.
Third, with a strategy to operate with a leaner-in-store inventory, the fresh product offering is robust and this increases the brand pull. I mention brand pull and to back my point, the company’s comparable store sale increased by 3% in FY14 as compared to FY13. Further, in 1Q 2015, the company’s total sales increased by 10% and comparable store sales were higher by 5%.
Besides these critical factors that will fuel EPS growth for Ross Stores in the long-term, I must also mention that the company has been doing well on the margin expansion front. For 1Q15, the company’s operating margin expanded to 15.7%, representing an increase of 110 basis points as compared to 14.6% in 1Q14. Increase in same store sales drove margins higher coupled with improvement in merchandise margin and lower distribution cost. While the company is targeting stable operating margins, continued increase in comparable store sales can benefit margin expansion.
With growth and margin expansion being two primary EPS upside trigger factors, share repurchase in another factor that will continue to boost EPS marginally in the coming years. In February 2015, the company approved a 2-year share repurchase program for $1.4 billion.
Another point I like about Ross Stores is the company’s solid balance sheet strength. As of May 2, 2015, the company had $762 million in cash with a long-term debt of just $396 million. Therefore, the company is net debt free and I believe that with annualized operating cash flows likely to be in the range of $1.2 to $1.4 billion, the company can further reduce debt. The company’s operating cash flow visibility also indicates that share repurchase programs will sustain in the coming years.
From a shareholder value creation perspective, dividends for 1Q15 increased by 15% to $0.1175 per share and I believe that robust dividend growth will sustain in the coming years in line with growth in revenue, EPS and operating cash flow as indicated above.
Coming to the valuations, Ross Stores expects EPS for FY15 in the range of $2.36 to $2.44 per share. This translates into a forward PE of 21.2 considering current stock price of $50.86. Ross Stores is therefore not trading at expensive valuations considering the point that the company has a strong expected growth trajectory.
Decatur Capital Management might have these points in consideration while adding exposure to Ross Stores and I believe that the company is certainly worth holding for the next 3-5 years. Investors can further investigate the company’s financial strength from the Guru Focus analysis page that rates Ross Stores 8 on 10 from a financial strength perspective and 9 on 10 from a profitability and growth perspective.
