August 9, 2016

Ross Stores: Management Concerns Holding Equity Up


Summary

  • Market expectations are for an improving Adjusted ROA for ROST, but management’s concerns about the sustainability of EPS and margin improvements imply that this may be unwarranted.
  • ROST is trading at an Adjusted Forward P/E of 21.8x, near the high end of historical valuations.
  • At these levels, the market is pricing in expectations for an improving Adjusted ROA, from 16.4% in 2016 to 18.8% in 2021, with no Adjusted Asset growth going forward.
  • Management’s lack of confidence and concerns about lagging performance indicate that market expectations may be too bullish and that near-term equity upside may be limited for ROST.

ROST - PVP - 2016 08

Performance and Valuation Prime™ Chart

ROST has historically seen cyclical Adjusted ROA (ROA’), peaking at 13.2% in 2003, before declining to a low of 8.7% in 2006. Since then, ROA’ has gradually improved, reaching new highs in 2011 at 14.3%, and further improved to 16.4% in 2016. Asset’ growth has been volatile as well, but has declined over time, declining from peak 18.1% levels in 2004 to 5.4% in 2010, before recovering to 11.9% in 2013. However, it has since tapered off to just 4.7% levels in 2016.

Performance Drivers – Sales, Margins, and Turns

It can be helpful to break down ROA’ into its DuPont formula parts, Earnings’ Margin and Asset’ Turns, which are the cleaned up margins and turns metrics used to calculate ROA’. The chart below details both Earnings’ Margin and Asset’ Turns historically, to help us better understand the drivers of the firm’s profitability and performance.

ROST - SMT - 2016 08 09

Valuation Matrix – ROA’ and Asset’ Growth as Drivers of Valuation

When valuing a company, it is important to consider more than a singular target price, and instead the potential value of a firm at various levels of performance. The below matrix highlights potential overvalued or undervalued prices for WYN at various levels of profitability (in terms of ROA’) and growth (Asset’ growth.) Prices that are in excess of 10% equity upside are highlighted in black, and prices representing an excess of 10% equity downside are highlighted in red.

ROST - VM - 2016 08 09


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