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Ross Stores, Inc. Stock Still Not Cheap Enough to Buy

Ross Stores stock - Ross Stores, Inc. Stock Still Not Cheap Enough to Buy

Source: Nicholas Eckhart via Flickr (Modified)

To buy Ross Stores, Inc. (NASDAQ:ROST) stock, investors have to answer two key questions. First, does the threat of, Inc. (NASDAQ:AMZN) and e-commerce more generally present a major risk to Ross Stores stock? If the answer is no — if the space is safe enough — then the next question becomes: Is ROST stock the best play?

I’m simply not confident enough in the answer to either question to see Ross Stores stock as all that compelling at this point. ROST is reasonably cheap, trading at 19x+ the midpoint of fiscal 2018 (ending January) EPS guidance.

But it’s still pricing in significant, consistent growth going forward, which implies the off-price channel will remain largely untouched by competition. Meanwhile, within the space, I’m not 100% sure Ross stock is the best play, given faster-growing rivals.

ROST has been an unbelievable performer for decades now (indeed, one of the best stocks in the entire market over the past 25 years), and there’s a solid case to simply stick with Ross Stores stock until something changes. But for now, the risks look a little too high — and so does the ROST stock price.

The Moat Question for Ross Stores Stock

The core question facing the off-price channel is just how deep its “moat” is. To what extent can the Ross model be replicated by online, or offline, competitors?

For the most part, I do think the off-price space is relatively protected. Certainly, Ross itself has had no troubles of late, with same-store sales growing 4% in each of the last three years.

The company is guiding for just a 1-2% increase in FY18, and that guidance sent ROST stock tumbling after earnings earlier this month. But many investors and analysts seem to believe that outlook simply is a case of Ross, as usual, being conservative in its initial projections.

Meanwhile, it’s not easy to argue that the off-price channel is next in line to see impact from e-commerce and omnichannel investing. Buyers at Ross and rival TJX Companies Inc (NYSE:TJX) have years of experience and important contacts.

Finding assortments that aren’t selling elsewhere but will sell at Ross is, for now anyway, a difficult-to-replicate art, not a science. And if the Ross/TJX model worked online, one would think that by now someone would have succeeded at it.

Another long-running concern facing the group is that inventory options may start to shrink. As clothing manufacturers improve their supply chain, and retailers shrink their own on-hand inventories, it may become tougher and tougher for Ross to find quality merchandise.

But on the Q4 conference call, Ross management dismissed questions about supply. Its peers have done the same as well of late. Overall, the off-price channel still seems reasonably healthy, and there still seems little reason for that to change any time soon.

Is Ross Stock the Best Play?

The off-price channel does seem reasonably healthy. But so does the valuation assigned to the sector, including Ross stock. And as we’ve seen in the auto parts space, among other retail niches, fears of online competition can arise very quickly.

As far as Ross itself goes, earnings are guided basically flat this year, excluding the effects of tax reform. Ross did hike its dividend, but it still yields a little over 1%. A 19x multiple for limited EPS growth doesn’t seem a particularly attractive deal.

To be fair, Ross’s guidance may be conservative. Revenue is being hit by tough multiyear comparisons, with three consecutive years of 4% growth, as noted, and a better multiyear performance than TJX. Ross also is hiking wages this year, adding pressure to margins. There’s a strong case that growth will reaccelerate in FY19.

I do like Ross stock better than TJX, which I thought was fairly valued back around $70 (it’s since gained almost 20%). Smaller Ollie’s Bargain Outlet Holdings Inc (NASDAQ:OLLI) looks expensive as well, trading at a whopping 37x forward EPS. But the most interesting play in the space still looks like Burlington Stores Inc (NYSE:BURL).

Burlington stock already has seen huge gains, as the stock has tripled in less than two and a half years. But its growth continues to be torrid. On a percentage basis, it has more room for store openings than Ross or TJX. And while it’s more expensive than ROST stock, it’s not prohibitively so. BURL trades at 19x fiscal 2019 EPS, a multiple that company certainly can grow into.

As such, it’s tough to get too excited about Ross growth at the moment. It’s cheaper than BURL, but not noticeably so. It’s outperformed TJX, but it’s also valued at a premium to its long-running rival. Growth should be solid in fiscal 2018, but even consensus EPS suggests single-digit growth, excluding one-time tax help.

All told, Ross Stores stock looks priced about right. It would take a pullback to make it more compelling. After all, Ross Stores investors should be like Ross Stores shoppers: looking for a bargain. Right now, ROST stock isn’t one.

As of this writing, Vince Martin has no positions in any securities mentioned.

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