Description

Ross has been a high performing company and stock for the past twenty years, with identifiable advantages and high returns on capital. I believe current guided earnings are a coiled spring with upside catalysts that are likely to lead to significant EPS and free cash flow growth materially above analyst estimates. Ross doesn’t screen overly cheap, guides conservatively, and has a net cash balance sheet with ongoing capital return that makes this an overlooked opportunity to own a good business with significant upside and a decade-plus growth runway ahead.

Highlights:

1. Economic uncertainty has historically benefited off-price retail

2. Elevated retail store closures create a market share opportunity

3. Demand inelasticity and untapped pricing power being exercised

4. Conservative, tenured management team providing multiple confidence signals

Business Overview

Ross is a high-return business in the attractive off-price retail industry. Full-price apparel and department stores have historically ceded market share to off-price as the treasure hunt experience and the 20-60% brand-name discounts appeal to customers. Ross’s core customers visit 2-3 times per month on average as there is a weekly flow of fresh, fast-turning merchandise. Scale, inventory data, and buying expertise are important. Ross and TJX are the industry leaders by store base, and Burlington is #3 at under half the size of Ross. Off-price buyers are in the market sourcing deals from thousands of merchandise vendors each day. There are no supply contracts to ensure steady inventory. Product turns quickly - simply calculated inventory turnover is 6-7x but a significant portion of inventory is warehoused as “packaway” (described below), so in-store inventory turns are much higher. SKU breadth and depth isn’t consistent which creates the unique in-store “treasure hunt” and doesn’t lend to a profitable e-commerce business when also considering an average-unit-retail (AUR) of $11 that doesn’t economically support marketing plus shipping costs. Also, name brands don’t want their apparel advertised online at 20-60% discounts from typical pricing, which dilutes brand value. Ross strictly sells in-store without brand specific marketing. For consumers to get the value, they must visit the stores and seek out the deal. Finding a great deal and saving money can be a thrill for customers and also drives free word-of-mouth marketing for Ross.

To be an attractive inventory off-load partner for vendors, a buyer must have extensive distribution to quickly take large or unique apparel deals with minimal requirements. Buying power and simple vendor delivery to a distribution center also afford larger discounts for scaled operators. These dynamics create a barrier to entry in establishing vendor relationships and sourcing deal flow, as the big three are able to take meaningful quantities, store or sell the product quickly, and be back for more. Due to internally developed inventory forecasting processes, Ross can operate with lean in-store inventories and keeps stock closeby in “packaway inventory” warehouses that provide storage for upcoming seasons and flexibility to remain “open to buy” when great deals come available. Ross can supply multiple weekly deliveries to stores in order to “chase” above-plan demand and capture more sales. Their use of packaway inventory grew following the initiatives described below.

Inventory planning is critical for off-price profitability. Ross developed their “micro-merchandising” system which dictates the supply assortment store-by-store using historical data in a bottom-up planning approach rather than a top-down, chain-wide assortment that Ross used to operate prior to implementing the data driven processes in the mid-2000’s. The objective was to improve at sending the right merchandise to the right store at the right time to drive faster turnover and better margins. This is not a simple process with uncertain supply. All stores are supplied by each distribution center, selling apparel is seasonal and difficult to forecast, and again, Ross operates with fast turns of a tremendous amount of different SKUs of uncertain available breadth/depth due to the nature of close-out buying and no supply contracts. For example, a store in urban-Michigan will have a different assortment than a store in suburban-Florida due to climate differences along with local demographics and trends. This makes each store assortment of a growing 2,000 store base unique and adds complexity to inventory management.

There were multiple speed-bumps in developing these processes but after many years Ross was able to operate with a more effective assortment of lower in-store inventories and better forecasting. Successful implementation resulted in higher sales productivity and margins. Following the mid-2000’s, inventory turns rose significantly. In-store inventory levels dropped 40% from 2007 to 2013 as Ross stocked stores lighter and kept more product in nearby packaway and DCs where it can be more efficiently routed to chase above plan sales at the store level. Having extensive accumulated data helps merchant execution on the buying team and helps forecasting for more effective distribution of assortments. Due to these factors, optimal off-price inventory management is difficult to execute and allows Ross to capture abnormal economic profits through high turnover and merchandise margin. This also benefits Ross in the form of more flexible late-cycle buying, better sales capture, sharp pricing, and lower markdowns. 

Ross has over 900 merchants on the buying team and strategically located offices to support relationships with vendors. The off-price industry’s importance to these vendors has grown over time as retail has consolidated and buying orders from off-price get larger year after year. Merchants have considerable discretion in their buying and operate on a deal-by-deal basis late in the retail purchasing cycle, making experience an important factor to execute off-price strategies. Ross has historically invested heavily in the buying team and considers it their most strategic asset. I don’t see this as a business that is easy to displace, considering Ross has achieved significant distribution scale with a low-cost real estate model, has extensive inventory data, and drives high unit volumes to maintain the lowest prices on brand name apparel.

Investment Thesis

The current setup for Ross has multiple positive drivers. In my opinion, the 2022 EPS guide given by management is poised for significant growth going forward. The highlights are:

1. Economic uncertainty & inflation

2. Record amount of retail store closures in 2019 and 2020

3. New pricing approach with demand inelasticity

As the lowest priced offering of branded apparel, the off-price industry has historically benefited during challenging economic periods. While today is certainly unique, Ross results from the 2007 to 2012 period demonstrate the strength of the model throughout a brutal environment for consumers. After posting average annual comparable store sales increase of 2.2% in the five years up to 2007, Ross posted an average comp of 4.8% from 2008-2012 and a 6% positive comp in 2009, a year when U.S. GDP was down and sales at apparel stores also fell. Some of this was due to inventory initiatives described above, but it’s likely Ross also benefited from a trade down customer as traffic was up over this period. Ross rarely has a negative same store comparable sales year.

Consumers can save money at Ross as compared to specialty retail and department store alternatives. With inflation at 40-year highs and gas prices around the “psychological $4 barrier” that can effect budget decisions, it is becoming increasingly likely that the consumer may be pressured by broad based price increases across the economy. In addition, the consumer sentiment index has receded significantly; it is now lower than during the worst of the pandemic and approaching 2011 levels. More consumers may be forced to make cost-based decisions in regards to discretionary apparel and home goods spending. Whether or not economic challenges come to fruition, off-price retailers have indicated that they feel good about the chance to gain a trade-down customer as value becomes more relevant in the midst of broad inflation pressure:

TJX Q4 ‘21 Call: “We are convinced that our relentless focus on value is a tremendous advantage and an inflationary environment, we believe, even more consumers will be seeking out value. We are confident that our value position will be a very attractive option for consumers looking to stretch their dollars without sacrificing on quality and brands.”

BURL Q3 ‘21 Call: “If I project forward to next year and just sort of add a thought about, if inflation really does take off in this economy, we actually think we may have a lot of new customers who are perhaps on slightly higher incomes, but they’re getting squeezed by higher price inflation. So that’s the reason why we feel somewhat optimistic that if there is inflation across the economy, consumers at different income levels are going to be more interested than ever in the value that we offer.”

ROST Q4 ’21 Call: “Our customer has always been focused on value. But as the world is evolving and this inflation, we actually feel we have an opportunity to gain a trade-down customer at the same time.”

One can logically expect that, relative to other consumer discretionary companies, Ross may benefit from inflation pressure on consumers given consumers can stretch dollars by shopping at Ross. In my opinion this provides a degree of inflation protection when combined with the pricing initiatives I will detail later on.

Another tailwind for Ross and off-price in general is the record level of store closures in the past few years. Cumulative U.S. retail store closures in 2019 and 2020 were over 22,000, more than double the 10,600 closed in the two peak-closure years of 2008 and 2009 during the Great Recession. This is a market share opportunity. As discussed, comp store sales growth for the few years following ‘08 and ‘09 averaged 5%. Whether or not this was due to a value-oriented consumer or fewer brick and mortar competitors, off-price has both as a tailwind now:

TJX Q2 ‘21 Call: Further, with a significant number of permanent retail closures in these geographies over the last 18 months, we see a great opportunity to capture a bigger share of consumers’ wallets going forward… a lot of store closures around us, a lot of them were branded apparel retailers where certain boxes have closed.

There are fewer places retail spending dollars go than there were just three years ago. Some will be spent online, but as online apparel prices rose 17% in 2021, those looking for value in an inflationary environment should go to off-price. This leads to the topic of pricing.

An interesting development happening currently in the off-price industry is their willingness to begin raising prices, which they historically have not done as an initiative to improve profitability. To set the backdrop, for many years before the pandemic Ross was able to maintain profitability on a flat to declining AUR by selling more units year after year. During 2015-2019 comps averaged 3.8% and by parsing through prior earnings calls, the common theme in this period was a flat to declining AUR, some due to category shifts. For perspective, on a 2006 earnings call Ross noted that average AUR was around $10 at that time. In 2019, Ross noted their average AUR as “$10 to $11” which was likely similar or lower in 2021. This is 10% or less AUR inflation over 15 years, a period in which $10 in 2006 is equivalent to nearly $15 today. Bear in mind some of this was driven by product and category shifts and not entirely by same product pricing. However, Ross maintained their discount to broad retail pricing to keep their value promise to the customer during a generally promotional retail environment which meant not pushing price. This means that the majority of comp sales growth was driven by more units, and I imagine that the prior low-inflation environment plus growing purchasing power over vendors allowed Ross to keep unit costs down and COGS in check. Gross margins were relatively stable through the period.

Today is much different. In the past year, Ross has been met with rising freight costs and wages that have dented gross margins and de-levered operating margin by 300 bps in H2 2021 as compared to pre-Covid levels of 13-14%. Due to these pressures Ross has guided for 2022 operating margin at 11.6% to 12.1% assuming freight costs ease in the second half on easier comparisons. Ross is in the price differential business, targeting specific discounts to other stores. Broad retail raised prices significantly and discounted less in 2021. Brands and department stores focused on profitability above growth by selling less units at higher prices. This is good for Ross as their pricing differential becomes stronger. Ross’s former CEO spoke to this on the Q4 2011 conference call, another period in which department stores were firm on pricing: 

“First off, we believe off-price, and specifically our model, does well in good times and bad times. It's been a while since the environment became less promotional. Off-price, specifically Ross, we do better when we're in a non-promotional environment or less promotional environment.”

Earlier in 2021, sentiment in the off-price industry was that the retail price increase and lack of discounting was transitory and off-price margins would be driven by comp sales growth, largely meaning more units, and not necessarily through higher prices. In Q2 ‘21 Ross and Burlington remained skeptical towards raising prices and expected retail’s higher realized prices, which they price price to, not to last:

ROST Q2 ‘21: “The higher prices at traditional retailers could increase the pricing gap that we offer and strengthen the values that we provide to our shoppers. And quite frankly, the merchants are constantly making those price value assessments of their assortments all the time. They’re prioritizing, as we’ll always prioritize, really having sharply priced assortments for our entire store. So at this point, I wouldn’t talk anything more about it for competitive reasons. But the one comment that I would say is we won’t be the leader in terms of raising prices.”

BURL Q2 ‘21: “I would say that we are very skeptical about the ability of retailers to sustainably raise prices across the categories that we compete in. There are really two reasons for that skepticism: firstly, it’s important to grow our distinction between higher realized prices in the short-term versus permanently higher prices longer term. It’s clear the inventory levels across the retail industry have been very lean this year, and as a consequence there has been very little promotional activity. That means that realized prices have been higher for many retailers. But we just don’t think that’s sustainable. 

TJX, on the other hand, changed the tone rather quickly in recognizing that broad retail price increases create a large opportunity for them to take price while maintaining appropriate price differentials, which they began doing in 2021. Ross and Burlington followed suit with pricing tests. It would be useful to read the last two quarterly calls for the three retailers, as significant detail is provided in regards to the industry’s pricing opportunity. The off-pricers see their current pricing at the widest value-gap compared to specialty apparel and department stores as it has ever been. This is significant untapped pricing power. Here are some important points from the calls, underline for emphasis:

BURL Q3 ‘21: “Our business is a third bigger now than it was in 2019. One reason for this is that our value differentiation versus other retailers has grown. The delta between the price of an item at Burlington and the price of a like item at a full price store has never been greater…  If these higher prices are sustained even as supply loosens up, then we think we will have a tremendous opportunity to drive sales or to take up retails or to do both. And if there is a general rise in inflation across the whole economy, then this opportunity could be even greater.”

BURL Q4 ‘21: “We have room to raise prices, but still offer great value to shoppers. We have already started to move up our prices, and we will get more aggressive in the coming quarters… Over the last few months, we’ve selectively tested higher retail prices. And so far, we have not seen any major issues.”

TJX Q4 ‘21: “We are getting price increases across the board… I would say every division, we can see directionally the pricing strategy is working. Again, we also get feedback on what’s happening. So, we monitor how we are doing with the goods that we’ve adjusted price on and that’s across every division and it’s extremely successful. No problems at all… I think this is really opposite of what we’ve seen for many, many years where our average retails were going down over a multi-year period. And I might have Ernie jump back in there. With our average retail going up, we’re still finding an overall unit base average retail significantly below what we were couple of years ago. So, I think with your average retails going up, and as Ernie alluded to, potentially less units, that’s what’s driving us to be offsetting a lot of these costs, not just the mark-on, but by having less units, less processing cost that was sourced in distribution centers and all that. And I think that’s a significant benefit versus prior years when it was going the other direction… We do a lot of marketing and other surveys, and our customers are telling us they’re highly satisfied with the overall store experience, which is great, and continues to go up, but they’re also — we’re not seeing any degradation at all in our value perception at all.”

ROST Q4 ‘21: “We have put in a strategic process, where we actually go in and the buyers are constantly assessing the market to understand pricing and where there were potential opportunities to increase that pricing. And we started that last quarter and it continued through this quarter. And the average price per SKU was up somewhat during the quarter. The way we’re looking at it is, we’ve had successes in many areas now compared to where we were, and we are watching it and evaluating it. And I would say, being cautious about moving the needle, based off of where we sit in the food chain… So — there’s a lot of variables, which is why we have processes in place, and we’re doing it strategically. But where we have done it strategically and continue to offer value to the customer, great values, it is working.”

So far all three retailers have reported no customer pushback to tested price increases. This makes sense for a few reasons I would point out:

1. If their price-gap to broad retail is wider than ever, then the customer will still feel as if they’re getting a great deal even if the price rises 5%. 

2. On a low average AUR (think $11 t-shirts), moving price up to $12 is not all that noticeable due to the low dollar amount increase, even though this is a 9% price increase and immensely profitable for a retailer like Ross which sold around 1.7 billion units in 2021 by my estimate. 

3. Even if the customer notices the price increase, the broad ongoing inflation pressures make it more acceptable to consumers now well aware of this issue.

In this context, and for Ross, it becomes interesting to consider the basics of gross profit: price per unit, cost per unit, and total units. This is the first time that Ross comp store sales growth may be significantly driven by price increases rather than units. It seems that off-price's unit driven model is undergoing a slight tweak from prior years:

TJX Q2 ‘21:  I think one of the benefits to having our average retail improve over the last couple quarters is as that happens, our costs, it helps us on our cost structure as well as it takes — you’ll have fewer units to move in our stores, DC and freight. 

Inventory handling is a significant portion of the cost structure for off-price. Looking at how this impacts profits, I’ve simplified the 2021 P&L for Ross indexed to $100 of sales on an $11 AUR. Then making basic assumptions for pricing initiatives: a 5% price increase results in a 2% decline in unit sales as some customers balk at paying more, while COGS/unit increases 3%... not as fast as AUR because Ross is essentially taking back the lost margin that other retailers were sooner to raise price on in 2021. 

What’s really intriguing here is that while revenues increase less than 3%, gross profit dollars increase 8%. Now the important KPIs are identified: units sold, AUR, COGS per unit, and SG&A costs. One can make some assumptions about how impactful the pricing initiatives can be for Ross based on the facts we know today; this helps to get an idea for sales and margins going forward.

• Units. All three off-price retailers reported success with price increases and no customer pushback, so there is some inelasticity to demand so far. Given that historically 3-4% comp growth for Ross has been driven mostly by increases in same-store units, it’s hard to imagine a situation where units sold will decline meaningfully due to the discreet “small dollar amount” price increase at play. If 2021 stimulus effects are underestimated and the business resets lower, that presents a short-term risk. The trade-down customer potential and store closure dynamics discussed above should also be taken into account in the demand picture. It’s realistic, and in my opinion likely, that units sold will continue to increase after the 2022 stimulus lap despite price increases.

• AUR and COGS per unit. The biggest question here is how much of the “historically wide” pricing gap between off-price and broad retail can Ross take back through price increases above the increase in cost of goods sold. This can’t be quantified exactly, but we can look to 2021 to see the general retail price increases happening around Ross as they’ve stayed firm on price and COGS rose:

• CPI for apparel increased 5.3% for the year ended January 2022 and accelerated to 6.6% for the recently released February CPI report

• Online apparel prices increased 17% in 2021, more than any other online category, and continued at 17% into February 2022 

• Tapestry brands reported low double-digit price increases generally

• Kohl’s plans less promotions as a way to take price - gave example of selling for 35% off rather than 40% off

• Macy’s AUR was up 11% in 2021

• Gap offset roughly 450 bps of cost headwinds with AUR - implies 4-5% increase

• Nordstrom planned mid-single digit price increases

It’s reasonable to assume that, broadly, prices increased 5-10% in the apparel space in 2021. Off-price reacts late to these increases to maintain their discount, and just started selectively raising prices in late 2021. Taking back at least 100-200 bps of pricing above COGS seems like a conservative expectation given these facts and the historically wide price gap.

• SG&A. Ross has done a solid job at keeping SG&A costs in check given higher wages and COVID procedures that increased store operating costs. For 2021, SG&A was 15.2% of sales compared to 14.7% in 2019. However, 2021 included $74 million of COVID costs (PPE and sanitation) which are not a permanent cost. Removing these costs, SG&A was 14.8% of sales - close to 2019. On a per store basis, SG&A was $1.52 million and 13% above 2019 levels, reflecting actions Ross has taken to increase wages. Pre-COVID, SG&A per store was growing roughly 2% annually. Given COVID costs represent 2.5% of 2021 SG&A and will likely work themselves out, expect ‘22 and ‘23 SG&A growth to be managed tightly despite ongoing inflation. On a per store basis since 2019, SG&A is up twice the historical rate of increase. Thus, we’ve already seen some of the ongoing inflation in that number. SG&A per store should be modeled at 2% to 5% growth in the years ahead with these factors and assuming operating cost inflation higher than we used to see.

With these facts I made a range of assumptions going forward to compare to street estimates. In thinking about potential outcomes for raising price, unit volumes, and SG&A increases I chose to model base, bull, and bear outcomes to see the effects on forward earnings power:

BASE

For the base case, I expect units sold will rise slightly after a tough 2021 stimulus lap and in total Ross takes 100bps of price above COGS increases which is significantly less than price increases of the broad retail industry. For SG&A I modeled an above average increase due to inflation but considered COVID costs coming down and wage increases already enacted. Included in the share count reduction is 4% annual capital return from buybacks and the dividend yield assumed reinvested like a buyback. This puts 2023 EPS at $6.85 and 20% higher than analyst consensus at $5.71. These assumptions do not seem very aggressive given the KPI facts above.

BULL

For the bull case, I assumed units will rise in-line with historic levels despite price increases given the opportunity to gain a trade-down customer and store closures. Here, Ross gets more aggressive by taking 200bps of price above COGS. SG&A growth is higher given the significant increase in sales. 4% annual capital return remained the same and this puts 2023 EPS at $7.32 and 28% higher than consensus. Additionally 2024 EPS represents a PE of 10.7x on today’s price. This represents significant upside, and these bull-case KPI assumptions don’t seem heroic while matching up with the facts of the situation. I see this playing out in an environment in which broad retail prices remain firm and/or increase further, giving Ross a larger pricing gap to work with.

BEAR

For the bear case, I modeled units flat due to higher prices and Ross not being able to increase prices at the rate of COGS. This would be a case of continued challenging freight rates and cost pressures, along with above average SG&A growth due to ongoing wage inflation. With capital return at 4%, this would lead to 2023 EPS essentially at current consensus. This shows the bearishness in estimates that are not incorporating the healthy backdrop for off-price and the ability to take price. At $6.28 EPS in 2024 on a depressed margin for a low-cost operator, downside seems fairly well protected at today’s price.

Valuation

These scenarios are useful in thinking about valuation and how the current dynamics in the off-price industry may play out. Another important factor for valuation is management’s updated store potential reported with Q4 earnings. Management indicated the potential for 3,600 stores in the U.S., up from the 3,000 prior estimate. This implies nearly doubling the current store base over the next two decades at 3%-4% average annual unit growth given their typical pace of 90 net new stores per year. This is realistic for several reasons:

1. Management is historically conservative and has consistently raised this number over time (in 2009 the number was 1,200 stores) so I don’t expect they’d put out an aggressive forecast. 

2. Ross continues to open stores in their oldest market of California where they have the most stores for a single state, growing to 443 stores in 2021 from 379 in 2017. 23% of Ross’s stores are in California which hosts just 6% of total MSA’s in the country. This doesn’t signal signs of saturation in existing markets. 

3. The record recent store closures provide a great supply of cheap sites for Ross to absorb. 

4. One-third of Ross stores are a co-tenant with a TJX brand store and perform up to chain average which shows the flexibility of their real estate strategy without hurting store performance.

In my view the increased store potential is a significant increase in terminal value if Ross keeps executing, and combined with comps at existing stores can potentially result in steady, HSD operating income growth for many years. Ross is a mature, advantaged business that can compound per-share metrics at low-to-mid double digits due to strong capital returns and priced at 17x 2022 consensus on an operating margin that contains abnormal freight costs and depressed pricing. I don’t feel that forward estimates consider the off-price demand backdrop against the typical quiet guide from Ross management. As Ross CEO, Barbara Rentler, said: “We are watching the retails move in our competition and all types of competition because the merchants are studying that and where we think we have that opportunity, and we can still offer unbelievable value to the customer, we’re taking it.” Those last few words are meaningful considering she is typically quite short and conservative on calls, especially relative to peers. It’s unlikely that Ross is going to roll over and eat these cost increases.

From 2015-2019, ROST consistently traded above 20x TTM earnings and at that time implied growth was lower with the store potential at 2,500 prior to 2018, subsequently raised to 3,000 that year. Ross has briefly traded at a mid-teens multiple at attractive buying opportunities in the past decade. The potential to compound EPS double-digits, recession resilience, cost competitiveness, and an excellent management team should justify ROST a multiple near or above the market with the S&P 500 at 20x 2022 estimates.

Using the bear, base, and bull outcomes - with a trough multiple of 15x, base multiple of 19x, and a bull multiple of 22x - my ‘24 estimates would have ROST valued in a range of $95 to $190 end-2024, and a base value of $150. This represents an expected three-year IRR range of 1% to 27% and base IRR of 17%. In this situation it appears that returns can be fair on disappointing results. Ross has the potential to compound double digits for a decade or more with the proven Ross model: 4% store base growth, 3% comps, 4-5% capital return. With no multiple expansion this would result in attractive returns for quite some time.

On a FCF basis, base case 2024 FCF per-share represents nearly a 9% yield on today’s price which represents good value considering quality and growth potential. Another interesting valuation perspective is that prior to COVID Ross traded in line with the S&P 500 on price-to-sales. Today Ross trades at 1.5x sales while the S&P trades at 2.6x sales. The extent of this dislocation doesn’t make sense given Ross exits the pandemic with higher sales, a stronger balance sheet, and better competitive positioning. Also, there is an identified path to reclaiming profitability, and Ross can compound sales per share at double the rate of reasonable estimates for the S&P 500. In any case, Ross appears to be an asymmetric bet given the qualitative nature of the business model, a strong balance sheet, the industry’s rational pricing and price-advantage, and the current stock price.

Management

Ross is a promote-from-within organization with unique levels of management tenure. The prior Chairman, Michael Balmuth, joined Ross in 1989. He is being replaced this year by George Orman who is aligned by owning 1.6% of the shares (worth $500 million) and has been on the board since 1982. The CEO, Barbara Rentler, joined in 1986 and progressed through various merchandising positions. The COO joined in 2000. The President of Ops and Tech joined in 2004. Average years of experience with Ross for these four executives is 28 years. The new Chair and the CEO have combined experience with Ross of 74 years. Five board members have sat for over ten years. These are good signs to ensure the proper management of the long-term health of the business. 

Of the three off-price retailers, it’s pretty clear that the Ross team is the most conservative and typically provides very little detail along with low guidance. The board just authorized a $1.9 billion two-year buyback equal to 6% of the market cap, raised the dividend 9%, and on the most recent call they mentioned a return to their double-digit EPS growth algorithm which stood out because it is not a phrase they have used in past calls. I see this as a signal of management confidence that trough-margins may be near along with a positive outlook.

Balance Sheet

Ross has a very strong balance sheet with $5 billion of cash and $2.5 billion of long-term debt, the majority of which was issued to bolster liquidity during COVID. Historically Ross operates with minimal debt and a net cash position of $1 billion. The liquidity gives flexibility for the buying teams to secure great deals. Given this, I’m expecting about $1.5 billion of the net cash to be returned to shareholders over the next few years, which represents 5% of the current price and is a nice margin of safety along with the very liquid balance sheet. Share count reduction may be accelerated by this. 

Risks

1. The new strategy of tighter inventory and lower promotions by broad retail and department stores may result in lower supply availability for off-price. This could turn what I expect to be a positive for Ross into a neutral or negative. Given longer lead times post-COVID and continued difficulty forecasting retail demand, I expect Ross to continue finding supply as an attractive off-load partner for vendors.

2. Inventories build and retail becomes promotional again, pressuring margins.

3. Federal stimulus effects may be underestimated when basing off of 2021 numbers. In this case the business could reset lower. I see this as limited, as Burlington gave confidence in an estimate that during the peak stimulus period of early 2021 it accounted for 10-15% of their 20% Q1 comp. Ross Q1 comp was lower and then remained more consistent throughout the year as stimulus waned. Even removing a portion of 1Q21 comps still has sales productivity notably above 2019 levels despite being at or below 2019 pricing.

4. Accelerating inflation and wages may make it difficult for Ross to accurately price to costs and impair the customers value perception if continuous elevated price increases must be taken. A counter to the rising wages is that higher wages can benefit retail as a revenue driver.

Catalyst

- 2H ‘22 results. Ross will be lapping the worst of freight cost increases from 2H ‘21 and the slowdown in traffic due to omicron. Pricing initiatives will be further along with a consumer looking for value in an economic environment that looks increasingly challenging. Supply assortment should also be very robust as ongoing supply chain delays favor Ross’s buying strategies. This will coincide with a shrinking share count given ongoing capital return.

- Off-price is more aggressive than expected in taking price given the widest discount ever to their pricing comps. This will play out over 2022 and 2023.

- Double digit compounding of sales and earnings per share.