At all times, but especially during these times when inflation is high, consumers are likely looking for attractive deals when it comes to everyday essentials, including clothing and other related goods. One company in this space that investors might initially be drawn to is Ross Stores (NASDAQ:ROST). Management has a solid track record of growing the company’s top and bottom lines, including cash flow. Long term, the trajectory for the company looks positive. And with management set to report financial results covering the third quarter of the 2022 fiscal year after the market closes on Nov. 17, there’s an opportunity for the company to further prove itself to its shareholders. As we approach that time, however, I do think that investors would be wise to take a more cautious approach. Financial performance so far this year has been disappointing, with sales and profits both falling year over year. Add on top of this the fact that shares don’t look all that appetizing from a valuation perspective, and I do think that there are probably better prospects to be had at this time.
Not at a discount
It has been a long time since I have written an article about Ross Stores. The last article I published about the company, in fact, came out in July of 2017. But in that article, I rated the company a “buy,” reflecting my belief that it should outperform the broader market for the foreseeable future. At that time, I called the company a quality operator but I also concluded that shares were looking a bit lofty from a valuation perspective. At the end of the day though, I felt as though the upside exceeded the risks. So far, that call has proven to be rather positive. While the S&P 500 is up 62%, shares of Ross Stores have generated upside of 87.1%.
Overall, the financial trajectory of the company over these past few years has warranted this kind of upside. Revenue went from $14.13 billion in 2017 to $18.92 billion in 2021. With the exception of the 2020 fiscal year when the company, like so many others, suffered from the COVID-19 pandemic, sales have increased year after year. Some of this rise has come as a result of higher comparable store sales. Between 2017 and 2019, comparable store sales growth averaged between 3% and 4%. In 2021, rebounding from the pandemic, this number was 13%. But the bigger driver was a significant rise in store count. The company went from 1,622 locations in 2017 to 1,923 by the end of 2021.
On the bottom line, the picture has been similar. Net income rose from $1.36 billion to $1.72 billion over the same window of time. Operating cash flow has been a bit lumpier. Between 2017 and 2020, it also increased, rising from $1.68 billion to $2.25 billion. Then, in 2021, it dropped to $1.74 billion. But if we adjust for changes in working capital, the metric ultimately rose from $1.72 billion to an all-time high of $2.23 billion over the same five-year window. Meanwhile, EBITDA for the business also increased almost every year, climbing from $2.36 billion to $2.69 billion.
So far for 2022, things have not gone exactly great. Revenue in the first half of the year, for instance, totaled $8.92 billion. This represents a decrease of 4.3% compared to the $9.32 billion the company generated at the same time last year. This is not because of a change in store count but, instead, is in spite of it. The company went from having 1,896 locations in operation in the first half of 2021 to 1,980 by the end of the second quarter this year. Instead, the company suffered from a 7% decline in comparable store sales, driven by a mixture of factors. Primarily, the company said that robust government stimulus and pent-up consumer demand from the prior year made sales then even greater than they otherwise might have been. So some of this change is a return to normalcy for the business. In addition to that, however, management cited escalating inflationary pressures and the impact those are having on consumer disposable income.
As with any asset-intensive business, when sales fall, you also should expect profits to fall materially. This case is no exception. Net income of $723 million pales in comparison to the $970.7 million reported in the first half of 2021. Operating cash flow plunged from $1.35 billion to negative $56.3 million. Though if we adjust for changes in working capital, it would have fallen more modestly from $1.24 billion to $1.03 billion. Meanwhile, EBITDA also took a step back, falling from $1.49 billion to $1.03 billion.
When management announces financial results covering the third quarter of the current fiscal year, the company will have an opportunity to surprise investors. At the same time, it will also have the opportunity to disappoint them. You see, at present, analysts are anticipating revenue for the third quarter of $4.37 billion. This compares to the $4.58 billion the company reported in the third quarter of 2021. Management has not provided any real guidance when it comes to sales for the third quarter. But they did say that comparable store sales should drop by between 7% and 9%. If this were the only factor in the formula, then it wouldn’t be hard to estimate what sales might be. But the picture has been made infinitely more complicated by the fact that the company went through something of a growth spurt in recent months. Between September and October of this year alone, the company opened 40 new stores, completing its goal of 99 store openings for this year and finally exceeding the 2,000 locations in operation it was aiming to exceed.
The picture on the bottom line should be clearer. At present, analysts are anticipating earnings per share of $0.82. Management, meanwhile, has been forecasting earnings for the quarter of between $0.72 per share and $0.83 per share. So analysts are aiming for the top end of guidance, meaning that there’s a lot of opportunity for the company to fail to live up to expectations. By comparison, last year, the company reported earnings per share of $1.09, translating to net income of $385 million. If current estimates are hit, then this member should drop to $283.8 million for the year. While the decline in sales will certainly play a part in this, it’s also true that costs this year have been problematic for the company. Higher ocean freight costs and increased markdowns, as well as higher domestic freight costs driven by higher fuel and other issues, have all played a role and hurting the company’s bottom line. There have been other issues as well, such as a demand for higher wages. It remains to be seen how these will continue into the third quarter of this year and beyond.
For the 2022 fiscal year in its entirety, management is anticipating earnings per share of between $3.84 and $4.12. At the midpoint, that would translate to net income of $1.38 billion. If we annualize the other profitability metrics, we should get adjusted operating cash flow of $1.87 billion and EBITDA of $2.12 billion. These numbers would imply a forward price to earnings multiple of 24.2, a forward price to adjusted operating cash flow multiple of 17.9, and a forward EV to EBITDA multiple of 15.1. If, instead, we were to rely on data from 2021, these multiples would be 19.4, 14.9, and 11.9, respectively. As part of my analysis, I also compared the company to five similar retailers. On a price-to-earnings basis, these companies ranged from a low of 7.8 to a high of 63.5. In this case, three of the five companies were cheaper than our prospect. Using the price to operating cash flow approach, the range was between 5.3 and 42.8. And when it comes to the EV to EBITDA approach, the range was between 4.9 and 40.5. In both of these scenarios, two of the five were cheaper than our target.
|Company||Price/Earnings||Price/Operating Cash Flow||EV/EBITDA|
|Burlington Stores (BURL)||63.5||40.7||19.2|
|The Gap (GPS)||18.8||33.9||40.5|
|The Buckle (BKE)||7.8||8.1||4.9|
|Big Lots (BIG)||9.2||5.3||8.3|
|The TJX Companies (TJX)||27.0||42.8||15.3|
Based on all the data we have at our disposal, I do believe that the long-term outlook for Ross Stores is promising. But at present, the company is facing some issues and it could be a while before these get better. If the company was trading at a meaningful discount on both an absolute basis and relative to peers, I would find it to be very appealing indeed. But given where shares are priced right now, I do think that there are probably better prospects to be had today elsewhere. And because of that, I do think it currently warrants a “hold” rating.