Ross Stores ROST
September 21, 2007 - 10:32am EST by
2007 2008
Price: 26.07 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 3,600 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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*Ross Stores is a discount apparel and homegoods retailer operating more 817 stores (~30k sqft on average) stores across the US with the top three markets in CA, TX , and FL. Along with TJX (Marshalls and TJX Maxx), ROST dominates this particular niche, though any company that sells clothes or housewares is a competitor. The company is a semi-mature fast grower in the later second phase of growth (start-up, duplication, maturity) that generates a lot of free cash flow which is used to buy shares. The stock trades for 14x trailing earnings and 11x the VL $2.30 estimate for 2008. 

Here is why I like the company:
*modest option issuances.  From 2006, ROST has averaged issuing 1.3% of ending diluted  share count for the past 5 years
*substantial buyback plan.  ROST has purchased 865m in shares in the past 5 years ending in 2006; company bot 101m shares ytd
*relatively consistent same store sales history.  Other than 5 month stretch in 2004, ROST has consistently reported positive compares
*high returns on capital.  As noted on the VL sheet, ROST has averaged 20 to 30% returns on capital over its history
*solid balance sheet.  Q2 BS had 164m cash, 64m investment, and 150m LTD.  Inventory was down 1% on a store basis. 
*high cash flow relative to the market cap.  ROST trades for 3.6b yet generates more than 370m in gross cash flow.
*modest expansion possibilities.  Company believes it can expand the core chain beyond 1500. 
*modest dividend.  ROST pays a modestly growing dividend (currently 1.1%)
*in the past 3, 5 and 10 years, ROST has generated 918m, 1.49b, and 2.45b in cash flow compared to 529m, 808m, and 1.163b in CapEx
*fluctuating stock price.  For the past 4 years ROST has traded in a regular range of the low 20s to the low to mid 30s; the stock price is currently on the bottom part of this range
Here are some concerns:
*analyst seem to hate the company.   This is pure opinion on my part, but most analysts take the tack that the ROSTstory is half-empty vs. half-full.  I'm not entirely sure why, but ROST is not as consistent as TJX, has experienced some system issues that people refuse to forget, and generally puts on a glum performance in their conference calls (taking pains to emphasize the negatives while glossing over the positives)
*new market stores are not performing up to company expectations.  As far as I know, ROST has not clearly explained this statement but made the comment that newer market stores, particularly in the South, had not performed up to chain expectations.  Since this is the area of most growth, obviously this is a concern.  The company is currently sticking to a line that 'micro-merchandising' will solve this issue but this is a opaque hope at best with uncertain results.
*company continued to believe that inventory levels could be lower; flip-side to this is if they are right this will lead to better working capital usage.
*CapEx was elevated last year and this year; company is building a DC and CapEx has spiked to almost 290m projected this year so compared to past years ROST will generate little FCF in 2007; CapEx should be more normalized in 2008 (~150m)
*the newer concept, dd's, which targets an urban customer is producing uncertain results with a slower ramp-up than expected.  Given the challenges that TJX has experienced with AJWright, dd's is an uncertain 2nd growth vehicle.
What Has to Happen for the Company to Succeed
*people not hate retail stocks anymore.  ROST is not the only retailer taking it on the chin right now regardless of how they are doing.  You can buy a large number of retailers trading at less than 12x 2008 estimates so either the retailers in general are going into the toilet or the market is being irrational - take your pick.  Regardless, the sub-prime mess will be a distant memory 3 years from now.
*continue to buy shares and pay a dividend.   This is a given.  As the price comes down, ROST will be able to purchase more shares
*continue to control inventory and execute a rational expansion plan.  Again, a given.  ROST has given no indication they would do otherwise.
To be frank, I don't know what will move ROST higher cause other than retail-hate I'm not sure what is driving it lower.  Maybe the business falls apart in the next 12 or 18 months - it won't matter - the company will still be around and still making tons of money and when whatever great fiasco washes out they just continue on keeping on.   Just 6 months ago people would be salivating to take this company private but few care anymore and would rather own 4% treasuries than the possibility of a 10+% cash flow yield here; sure, it isn't free cash flow, but ROST has earned nice returns on its capital and has been  more than willing to share it with investors, so...


general market drift.
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