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Stock Screen: High Returns Earned on Total Capital - November 16, 2012
One quick way to cut through the large number of available investments is to review return on total capital. This statistic measures the percentage a company earns on its shareholders’ equity and long-term debt obligations. Value Line calculates this number, which appears in the Statistical Array on every research report, by dividing net profits plus half of the current year’s long-term interest due by the sum of shareholder equity and long-term debt. The general idea is to see how much a company earns on the money it has been given by outside investors. Companies with high scores are, presumably, better wards of capital.
That said, this measure is best used as a starting point and a comparison tool. Some industries will never show up on a screen of this nature, others will have many representatives. Thus, comparisons between companies in the same industry will provide more insight than comparisons between companies in different industries.
Since a quick review of this one measure can highlight companies that are making the best use of investor capital (on a combined basis from stock investors and bond investors), each weekly Index of The Value Line Investment Survey includes a screen listing the 50 companies that score high on this measure (subscribers can view recent and historical Index information here). A recent review of the screen turned up several companies worth a closer look, like Ross Stores, Inc. (ROST), and Monster Beverage (MNST).
Ross Stores, Inc.
Ross Stores, Inc. operates two brands of off-price retail apparel and home fashion stores: Ross Dress for Less (1,037 stores in 29 states) and dd’s DISCOUNTS (88 stores in seven states). The stores target value-conscious women and men between the ages of 18 and 54, but over two-thirds of its customers are women. The target income bracket for Ross Stores is middle income households, while dd’s DISCOUNTS attempts to lure patrons with more moderate income. The typical discount at Ross locations is 20% to 60% off regular department store prices on name brand, in-season, and fashionable apparel, accessories, footwear, and home fashions. By purchasing later in the merchandise buying cycle than department stores, ROST is able to take advantage of imbalances between retailers’ demand for products and manufacturers’ supply. Most of its apparel is acquired through opportunistic purchases created by manufacturer overruns and canceled orders both during and at the end of a season.
Yesterday, the company released third-quarter earnings of $0.72, which were 14% higher year over year, and in line with Value Line analyst Alex Mayo’s forecast. Sales were also healthy, advancing 11%, thanks to a 6% same-store sales gain. A mid single-digit traffic increase combined with a low single-digit jump in the average ticket drove the comp. The favorable results came across merchandise categories and geographies, but the juniors category stood out, as did the Southwest, Texas, and Florida regions. The operating margin grew 35 basis points year over year, as a higher merchandise margin and leverage on occupancy cost and distribution expenses offset increased buying and freight expenses.
Investors appear unimpressed with the company's fourth-quarter guidance of same-store sales in the 1%-2% range. This seems minuscule at first blush, but not as bad after considering last year’s fourth quarter comps rose 7%. Further, management has a history of providing conservative outlooks.
The company mentioned that the negative effects of Hurricane Sandy should be minimal since only a small percentage of its store base was impacted. In fact, there could be a sourcing benefit as the merchandisers it buys from likely had more inventory to unload as shopping was constrained by the storm.
Meanwhile, we expect the company to continue repurchasing shares. It bought back 1.7 million shares in the quarter, bringing the year to date total to 5.4 million, which cost $334 million dollars. It expects to purchase another $116 million during the fourth quarter, which will complete the two-year $900 million program announced in early 2011.
An uncertain spending environment, speculation over increased promotional activity, the difficult fourth quarter comparison, and cautious guidance have caused these shares to underperform the broader market by 17.3% over the past three months. We think investors are being overly pessimistic here. We view the consumer spending uncertainty as a plus not a minus, as the company’s value proposition for brand name goods ought to continue appealing to cost-conscious middle income consumers over the near-term. Even if economic conditions do improve, we predict savvy shopping will remain the norm and consumers will not be quick to abandon their value-oriented mindset, as this has yet to happen since the Great Recession officially concluded in 2009.
Monster Beverage Corp.
Monster Beverage Corp manufactures and distributes nonalcoholic beverages that include juices and teas. The company’s most notable product is its line of energy drinks, aptly named Monster. This segment accounts for the majority of Monster’s sales (92% of the 2011 tally). The portfolio of energy drinks consist of caffeine-based beverages as well as different types of energy shots. The company’s major market is North America but it has recently initiated launches in foreign regions like Japan and Europe.
Monster's third-quarter results disappointed investors. Earnings fell short of consensus estimates as profitability was hurt by a greater mix of low-margined international sales. The gross margin was also negatively impacted by damages and product losses related to the production and shipping of products for new markets like Korea and Japan. Volumes rose 18%, but net sales were only up 14%, due to the higher international sales and unfavorable currency exchange rates. Notably, sales in October were up 28% year over year.
Monster has faced some near-term headwinds, of late. In particular, the caffeine content information the company uses for promotional and labeling information is being investigated. Management spent a significant amount of time on the recent conference call defending its products, saying they contain half as much caffeine per ounce than most coffee blends. This has been confirmed by independent third parties. Still, in light of the issue, some investors recently headed for the exits. In our view, the selloff seems overdone because this hurdle may be easily overcome with revised labeling information. Further, we doubt the negative headlines will impact demand for immensely popular energy drinks very much. Therefore, recent stock-price declines may provide a good entry point for investors.
Arguably the biggest growth engine at present is the company’s recent penetration into foreign markets such as Japan and Europe. International launches have been well received thus far and we think there is room for market share gains.
At the time of this article's writing, the authors did not have positions in any of the companies mentioned.