This dividend-paying growth stock has had a tough time. Is it still a purchase?
Consumers have diverse preferences for just about anything you can imagine: electronics, clothing, and food, to name a few. But if there’s one thing every consumer can appreciate, it’s a bargain.
And with a market capitalization of $30 billion, few apparel retailers are reaching consumers with bargain prices quite like Ross Stores (ROST -2.48%). But after a tough second quarter, is the retailer still a buy? Let’s review the fundamentals and valuation of Ross Stores to see if it’s currently on the market for dividend growth investors.
The comparison period was difficult
Operating 1,669 Ross Dress for Less stores in 40 US states, Washington DC and Guam in the second quarter, Ross Stores is the largest discount apparel and home fashion chain in the United States. The company also operated 311 dd’s DISCOUNTS in 21 U.S. states with seasonal and branded apparel.
Ross Stores posted revenue of $4.6 billion in the second quarter, down 4.6% year-over-year. A drop in sales is something shareholders don’t want to see from their investments. But it’s important to understand that not all sales drops are the same.
The investment thesis that Ross Stores is a top destination for bargain hunters is not broken – the company’s second quarter results were largely driven by macroeconomic factors. The economic stimulus consumers spent in Ross Stores’ first and second quarters of 2021 led to a tough comparison period.
Indeed, the lack of economic stimulus in the last quarter, combined with a higher rate of inflation, led to a reduction in disposable income and consumer spending.
As a result, comparable store sales fell 7% from the same period a year ago in the second quarter. This decline in comparable store sales was partially offset by a 4.4% year-over-year increase in the total number of Ross Stores stores to 1,980, which explains why total sales declined less than comparable store sales for the quarter.
The discount retailer posted $1.11 of diluted earnings per share (EPS) in the second quarter, down 20.1% from a year ago. Higher freight costs caused the company’s net margin to decline 190 basis points to 8.4% in the quarter.
This decline in profitability was partially offset by a 2.5% year-over-year decline in the diluted number of Ross Stores shares outstanding to 346.1 million for the quarter.
Flexibility is built into the dividend
Ross Stores’ 1.4% dividend yield is slightly lower than the S&P500 dividend yield of 1.7% of the index. But this is offset by the safety and growth potential of the company’s dividend.
Indeed, the dividend payout ratio is expected to be below 31% for the current year. This payout ratio provides Ross Stores with sufficient capital to balance its capital expenditure needs for new store openings with debt reduction and share buybacks.
Due to macroeconomic headwinds, analysts expect the company’s diluted EPS to grow 3.8% annually over the next five years. Given the low payout ratio, I expect the single-digit annual dividend growth to continue over the next few years. It’s probably a good mix of starting income and future income.
Retailer is a long-term business
The sale of 22% of Ross Stores so far in 2022 has brought the stock back to a reasonably attractive valuation for value investors.
At the current share price of $88, Ross Stores is trading at a 12-month price-to-sales (P/S) ratio (TTM) of 1.7. This is slightly below the median 10-year TTM P/S ratio of 1.9. Given the company’s intact fundamentals, this looks like a deal that discount stock enthusiasts shouldn’t pass up.
Kody Kester has no position in the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.