Hunting For A Deal? Ross Stores May Just Be It

Key Points

• Shares of Ross Stores are trading higher in the after-market hours of Thursday evening; bullish sentiment comes amid the company reporting its first quarter 2023 earnings results. 
• Despite challenging economic conditions, the retailer still managed to grow its top line beyond inflation, rewarding employees and shareholders for their loyalty. 
• Management expects a flat year for the remainder of 2023, yet bulls overtake a stock advance; this rare occasion comes from management's massive capital pool to be deployed in share repurchases. 
• Analysts suggest a double-digit upside, and these fundamental valuation metrics agree, with further upside from good-old economic laws. 

Despite a choppy United States financial market, where investors are still digesting the aftermath of the FED raising rates in its attempt to control inflation, shares of Ross Stores NASDAQ: ROST fared strongly relative to the S&P 500 benchmark. ROST stock not only inched the day higher by 1.53% on Thursday's session, but it is also rallying by as much as 2.5% in the after-market hours of the evening. This advance in the after-hours is attributed to the company releasing its first quarter 2023 earnings results, where investors realized that the stock might be sitting on a nearly decade-long valuation compression.

Ross Stores' charts would show that the stock has outperformed other peers in the sector, advancing past names such as Burlington Stores NYSE: BURL and GAP NYSE: GPS by 14% and 41.5%, respectively. Despite Gap being one entrenched brand name in the American consumer's closet and also posing attractive upside potential for investors, or Burlington riding on the tailwind of stabilizing United States housing starts for home decorations, Ross Stores offers one key characteristic that peers do not; non-cyclicality. 

A Cost-Effective Castle

Ross Stores analyst rating points to a further 14% upside from today's prices, which does not consider the company's current dividend yield, which stands to reward investors with an annual 1.27% rate. During the company's first quarter 2023 earnings press release, CEO Barbara Rentler points out some of the critical strengths portraying the business' performance on a yearly comparison. With comparable store sales, a primary key performance indicator (KPI) for the retail industry in general, Ross Stores experienced a 1% increase.

However low this rate may seem, it is pegged against a national inflation rate of 6.3% as of April 2023, measured by the Consumer Price Index (CPI), and against a 3.7% net sales growth rate. These three different data points suggest, as well as judging by the stock's price action upon digesting the news that despite a challenging economic environment, Ross' business model enabled the company's financials to navigate it well and come out atop. 

Knowing the importance of employee satisfaction to keep customers returning, management rewarded employees via incentive compensation increases. As a result of beating past sales expectations, the company's operating income margin ended the quarter lower. Posting a 10.1% operating margin versus 10.8% from a year ago could have upset some investors. However, rewarding employees was first among management's tasks for the year, considering the challenging labor market environment posing shortage threats.

Nonetheless, investors could not have had time to be disgruntled at these payouts, as they, too, shared in the bounties of a remarkable year. In addition, management retired two million two hundred thousand shares off the open market during the period, returning $234 million to shareholders in the process, a sum that would represent 0.65% of the company's market capitalization. 

What's more important - and exciting - for investors is the remaining capital pool from the $950 million share repurchase program available for the rest of 2023.

Taking out the $234 million already deployed would leave an additional $716 million to be allocated toward share repurchases, or an aggregate 1.98% of the company's market capitalization. Ross is one of those companies whose stock still rallies amid management pointing to end-of-year outlooks having comparable store sales "...still planned to be relatively flat." the key lies in the stock's valuation from an investor's point of view.

Cheap Quality, In-Store and In-Stock

Ms. Rentler pointed out her earnings per share expectations for 2023 after laying out the flattish sales outlook. Investors can now expect to see 2023 earnings per share within the $4.77 to $4.99 range; looking at Ross Store's financials, this outlook would represent an 8.9% to a 14% bump from 2022 earnings per share.

Considering historical next-twelve-months price-to-earnings ratios, this expectation would place ROST stock at a 21.3x P/E multiple, which compares to an average past range of virtually 22.0x to 25.0x. Where the raw earnings multiple seems to do little justice for investors building a bullish case, the answer lies within the price-to-book value multiple. 

Currently, ROST stock carries an 8.4x price-to-book value multiple, when historically, this valuation metric has hovered around the 10.0x to 12.0x ranges. Increased earnings expectations for 2023, coupled with an easing of inventory conditions across the retail and apparel industry, are signs of a broader economy getting over the adverse effects caused by inflationary pressures.

What could drive this multiple upward, along with the book value of Ross itself, is a two-fold dynamic. First, economic recoveries lead to 'healthier' earnings which would not suffer from these macro challenges and therefore command a richer multiple. Furthermore, as management repurchases more shares with its remaining $716 million available for allocation, book value will automatically increase as shareholders gain more ownership of the growing pie.