Founded in 1950, headquartered in Dublin, California, ROSS Dress For Less is the largest off price retailer in the United States1. ROSS owns 1200+ stores in 33 states of US with over 300+ stores in California alone. Ross has limited or no presence in the Upper East (NYC, New England, NJ), Alaska and Midwest. ROST’s dd’s DISCOUNTS operates 150 stores in 15 states. In 2014, ROST employed approximately 71,000 employees (non-union) including full time and part-time employees2.
Retail clothing is a brutal business. It’s competitive, seasonal, and too dependent on the whims and fancies of the general public. The only positive is that, currently, it remains a tough place for the online giants to make inroads into. The way a dress “Fit”s is qualitative and varies from brand to brand.
ROST is somehow able to pull of a magical story despite these difficulties - ROST had over $11B in Total Sales in FY 2014 and (~7%) year on year sales growth. Further, as seen below, ROST has had incredibly ROIC over the last 5 years. The questions with ROST are simple:
- Is there really a moat going forward? Or is the ROIC a reflection of the lucky past?
- If so, what would be a fair price to pay for this business?
|FY 2014||FY 2013||FY 2012||FY 2011||FY 2010|
|FCF Per Share||$4.83||$3.64||$3.15||$0.88||$0.99|
The Qualitative Factors
Purchasing ROST believes that the key to its competitive advantage is to buy out of season clothing at a deep discount via professional negotiators purchasing in bulk. In their own words:
We believe that our ability to effectively execute certain off-price buying strategies is a key factor in our success … By purchasing later in the merchandise buying cycle than department, specialty, and discount stores, we are able to take advantage of imbalances between retailers’ demand for products and manufacturers’ supply of those products.
They look at themselves as an opportunistic purchaser, who specialize in retailing two ways:
- Close-outs: These are manufacturer overruns that are still in-season, but ROSS can get these at a discount because of cancelled orders.
- Packaway Purchases: Off-season purchases made at a deep discount that will be stored in their warehouses until a later date (sometimes even till the beginning of the same selling season the following year).
Packways in particular, are perceived by the management to be a good way of increasing prestige and brand image by including national well-known brands at extremely competitive savings.
Key to the above is ROST’s ability to warehouse packaways and distribute close-outs efficiently. In management’s words:
We ship all of our merchandise to our stores through these distribution centers, which are large, highly automated, and built to suit our specific off-price business model.
Currently ROST owns and operates five distribution processing facilities - 2 in California, 1 in Pennsylvania, and 2 in South Carolina. An additional distribution center in Shafter, California is currently under construction and expected to open in 2015
Retailing is a highly competitive industry. Apart from that ROSS believes it is subject to the following risk factors:
- Changes in level of consumer spending on apparel or home-related merchandise.
- Impacts from macro-economic environment affecting disposable income.
- A natural disaster in California - Corporate HQ, 2 operating centers, 2 warehouses, and 25% of stores in California (they carry some earthquake insurance).
- Ability to achieve planned gross margins by effectively managing inventories, markdowns, and inventory shortage.
- The risk that packaways will go out of fashion the following year.
All stores (except 3) are leased on a 5y - 21y (including renewals) original lease term. No store accounted for more than 1% of sales. They own all distribution centers (6), half their warehouses (4⁄7), and most of their office space (2⁄3). The leased warehouses are often ~50% the size they own, and the leased office space in LA is by far the smallest (~20% of their next biggest) office.
- Gross margin has consistently been between 28 to 29%.
- SG&A has consistently accounted for just 14.5 - 15.5% for sales. Management appears to have a tight leash on cost.
- Earnings net of interest and taxes are consistently between 7.5-8.5% of sales over the last 5 years.
Points of Note
- ROST has bought back shares aggressively: ~25% less shares outstanding in 5
- ROST grew at a great clip (~12%) even during the recession which confirms their appeal as a discount brand.
- Concern: Efficiency - While number of stores has only increased 29% from 2010 (1055 to 1362), number of employees have increased ~44% (from ~50k to ~71k).
- A raw 10x FCF valuation gives us a post-split price of ~$50. (no growth taken in account)
- Assuming ROST’s profits grow at ~7% for the next 5 years, tethering off to inflation after that for the next 10, we arrive at an intrinsic valuation of ~$45 (4% discount rate).
- The current price of $57 implies an EPS growth rate of ~10%.
ROST clearly has a moat, but one dependent on process. Process driven moats tend to be the weakest type of moats, as there is inherently nothing preventing competitors from copying it over a period of time. In this regard, it seems unclear how durable ROST’s competitive advantage really is.
Of course, this can still be a great investment if the purchase price can compensate for these unknowns. In my opinion, the current implied growth of ~10% does not provide a sufficient margin of safety to make this call.