Ross Stores Has Further To Run, But Not Much More

The U.S. economy remains in slow and unspectacular recovery mode, but this fact should not deter investors. Making money in the markets is not just about buying/selling stocks in line with the economy but, in my opinion, more about finding stocks that can surprise on the upside within an understanding of the future economic climate.

I think the off-price retailers are a good example of the sort of stock that has the potential to do well in this environment. In this article I’m going to focus on Ross Stores (NASDAQ: ROST). I will discuss its recent results and suggest some other names to look at.

Ross offers good value -- well, just about

I last looked at the stock in March in an article linked here. Since then the stock has done well, and I think it has a bit further to run. The recent rise is putting pressure on it to continue to outperform, but the good news is that current trading is pretty good.

As ever with Ross Stores it is worth noting that it tends to be conservative with its guidance. In the article linked above I referenced its guidance of 1-2% growth in comparable same store sales growth and suggested that it might beat that number. In the end the number came in at 3% for the quarter, and the guidance of 1-2% for the next quarter (and the full year) remains intact. Traffic was flat but an increase in the average basket size helped gross margins carry on their impressive performance.

Here is a table comparing its guidance with what it has reported:

As the notes in the graph suggest I think the market seems to expect Ross to beat its conservative same store sales guidance each time. If true, this could put pressure on the stock price should it fail to beat the range given for the next quarter. 

The 1-2% guidance is obviously something catching on in the industry because its rival TJX Companies (NYSE: TJX) tends to forecast in a similar manner.

What about the competition?

TJX is a useful company to compare and contrast with Ross because its same store sales came in at the top end of guidance with 2% growth; but the good news was that it guided towards 2-3% for the current quarter. The other interesting comparisons are that TJX is aggressively expanding into Europe and that it plans to launch an e-commerce initiative in the second half. By way of comparison Ross’ management declared that the economics of an e-commerce operation don’t ‘add up’ for the company. Will it work for TJX? And will either of these companies change their minds about e-commerce?

TJX’s home goods sales have been doing well while Ross had some disappointments last year and is somewhat playing catch-up. No matter, its management declared itself as ‘feeling good’ about the changes and said they were on track.

Another company worth watching in this context is J.C. Penney (NYSE: JCP). Frankly anyone would struggle to put this company’s difficulties as eloquently as Howard Davidowitz has done over the years. No prisoners taken when this guy gets fired up!

The good news is that the company has grasped the gauntlet and is starting to offer the kind of promotions that many think it needs to. Furthermore, it is pinning its hopes on expanding its home goods sales. Both of these activities will potentially increase competition for TJX and Ross, and investors need to watch events closely. The difficulty that J.C. Penney has is that it is exactly in the kind of mid-range retail space that this economy has ravaged.

Where next for Ross Stores?

In conclusion I think the stock has a bit more to run and I'm holding for now. Ross forecast EPS of $3.70-$3.81 for the full year, which puts it on a forward PE of around 17.2x as I write. In addition, this is a heavy investment year with a step-up in capital expenditures to around $670 million. The implied EPS growth rate of around 6.4% may not seem like much, but lets recall that last year's earnings contained a positive contribution of $0.10 from an extra week's sales. If you strip that out then the EPS guidance is for a more respectable 9.4% increase.

I think a target price of around $69 is reasonable given the risk of the extra capital expenditures (mainly to build out two new distribution centers), the possibility that J.C. Penney might get its act together and the chance that the market may be currently pricing the stock to keep beating its own guidance.