Ross Stores, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 5/5

Ross Stores operates as a discount retailer, focusing on offering name-brand apparel, accessories, footwear, and home fashions at savings of 20% to 70% off department and specialty store regular prices.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Ross is the largest off-price retailer in the U.S., a space that offers high profitability but is also subject to trend and price volatility.

  • Revenue Distribution: Ross operates through two brands: Ross Dress for Less and dd’s Discounts. Ross Dress for Less stores offer brand-name apparel, home fashions, and accessories at discount prices. dd’s Discounts stores provide a similar shopping experience, but focused on value-conscious customers. Both operate under the same organizational structure.
  • Industry Trends: The off-price retail market has benefited from value-conscious shoppers, who are attracted by discounts on brand-name merchandise. However, retailers in this sector are highly susceptible to fashion trends, which can fluctuate quickly and are hard to predict. Also, there is more and more competition from other off-price retailers, which affects the margins and market share of ROST.
  • Margins: Gross margins are relatively high and stable in this sector, typically around 20-30%, as off-price retailers sell goods at prices much lower than their value.
  • Competitive Landscape: The off-price retail space is highly fragmented, with several large players and numerous smaller companies. As more people flock to the off-price business, competition for the same resources and customer becomes more fierce and results in lower margins and more marketing expenditures.
  • What Makes Ross Different?
    • Ross’s focus is on providing a “treasure hunt” shopping experience with frequent and unpredictable changes in selection, which helps generate unique customer loyalty.
    • They also aim to provide a differentiated pricing position where merchandise is purchased and priced to achieve significant value and discount.
    • They use their supply chain and inventory management techniques to offer a greater assortment of branded apparel at lower prices.
    • The stores are not big and well designed, rather, they focus on being easy to navigate and are similar across most locations which reduces overhead and gives a consistent shopping experience to consumers.
  • Recent Concerns/Problems:
  • The CFO has been a long-term member of the management team. After the last earnings calls, it seems like it is not well know or communicated that he has been replaced. This shows that management has not always kept its communication with investors and the public strong.

Financial Analysis

  • Revenues: The company has shown steady revenue growth over the last several years with a 7.1% sales growth this year. The company has had a higher operating income mainly due to a 30 bps improvement in gross margins, which have been attributed to a decline in supply chain costs and improvements in transportation efficiency. But there has also been some pressure from higher incentive compensation.
    • In the latest reported quarter, there was a 10% increase in sales compared to the same quarter last year, which indicates good results.
  • Margins: Gross margins are good for the company. However, in the most recent quarter, the costs of goods sold have gone up by 220 bps compared to the same period last year, and thus impacted the operating margin negatively. Their gross margin is at 24%.
  • Expenses: Selling, general, and administrative (SG&A) expenses have also increased, due to higher incentive compensation, along with the impacts of adding new store locations, which impacted the earnings per share results.
  • Balance Sheet: The balance sheet shows high liquidity as well as long-term financial stability. The company has a current ratio above 1 and has low long-term debt, which is quite good. They also have a lot of cash on hand, which can be used to reinvest in the business. Ross has been doing share buybacks to decrease shares outstanding, which benefits shareholders by increasing earnings per share. They had 6.2 billion dollars in equity and 2.4 billion dollars in total liabilities, which indicates their good financial situation.

  • Capital Expenditures: The main use of capital is new stores and improving/expanding their existing facilities.

    • Earnings:
      • They report earnings per share which are consistent across the last several years. But their net earnings have decreased over the last year, which has to be seen in the context of the overall economic situation, which affects the sales volumes. Their earning per share was 1.49 in the latest quarter, compared to 1.33 in the same quarter last year.

Moat Rating: 2/5

Ross has a narrow but not strong moat. Its main advantages are its established brand, its ability to offer low prices and its scale with over 2000 stores. While these factors create some barriers to entry for new competitors, there is low differentiation of products. As a result, competitive pressure is always a risk. However, Ross’s size and scale do offer it some insulation from competitors, especially the smaller ones, allowing it to operate with more flexibility and at a lower cost than others in their same industry. Also, a large chain of stores enables Ross to acquire merchandise at a discount, which gives it a cost advantage.

  • Intangible Assets: The company’s brand name “Ross Dress for Less” helps attract customers and has some recognition, although it is not as strong or as high as other brands.
  • Switching Costs: Switching costs are very low, there is nothing stopping a customer from shopping from another retail brand or store.
  • Network Effects: The business does not benefit from network effects.
  • Cost Advantages: The company benefits from scale and scope advantages due to its purchasing power. Also, large distribution centers reduce transport costs.

Risks

Several key factors could potentially diminish Ross’s profitability or even undermine its moat:

  • Macroeconomic Factors: Economic downturns affect consumer spending, which would greatly impact Ross’s profitability. Ross could also struggle with inflation, which can cause consumer spending to go down while also increasing costs for the company.
  • Intense Competition: Increased competition from other off-price retailers as well as other discount-oriented retail formats could force Ross to compete more aggressively on price, which would hurt margins and make it more difficult for them to attract customers.
  • Trend Susceptibility: Being a fashion company that sells apparel makes it inherently susceptible to trend changes, which can happen rapidly and unexpectedly. If Ross misses out on some trends and isn’t able to keep up with demand for popular products, it might have difficulties as a business.
  • Disruptions to the Supply Chain: Any major disruptions to their supply chain, or new regulations could severely impact their ability to source products and reduce their profit margins.
  • Management Turnover: The CFO recently resigned after being with the company for a long time. Although this may create an opportunity, it can also create some uncertainty and volatility in the company during this transition phase.
  • Price-to-Value Mismatch: If their valuations get very high, then it would reduce the opportunity for positive returns from the company. It is always important to buy the company at a price that is lower than its true value.
  • Stock Buybacks: If the company decides to do stock buybacks again after they just completed their last one, it could be seen as management’s belief that the share is overvalued and signal a sell to investors.

Understandability Rating: 2/5

Although the business model is easy to understand, as it is a very simple retailer, the complexity of the financials, and especially the calculation of things like same-store sales, means this business is not as easily understood for more casual investors. I’m not talking about the “how” of the business, but the “why”.

Balance Sheet Health Rating: 5/5

Ross has a strong balance sheet with low debt levels, high liquidity, and good capital management. These qualities would give it the flexibility to grow and expand, and the flexibility to withstand major economic downturns, making it very safe from any financial distress or bankruptcy.