Ross Stores (ROST) Q2 Earnings Top, Stock Dips on Higher Cost

Ross Stores, Inc. ROST reported better-than-expected second-quarter fiscal 2018 results, wherein both top and bottom lines beat estimates and improved year over year. While the company has provided an optimistic view for the second half and an upbeat forecast for fiscal 2018. Projections of higher freight costs and wage investments are likely to weigh on operating profit, which has hurt investors’ sentiment.

Notably, higher freight costs have been a headwind for the company for over a year now. The increase mainly stemmed from significant rise in market rates due to a very tight capacity, resulting from driver shortages, impacts of increased regulation and the stronger economy. Consequently, the company expects headwinds related to higher freight costs to persist throughout fiscal 2018, which is reflected in its guidance.

On that note, shares of Ross Stores have declined 5.2% in yesterday’s after-hours session. However, this Zacks Rank #3 (Hold) stock has gained 22.8% in the past three months, outperforming the industry’s 15.9% upside.

Ross Store posted earnings of $1.04 per share, which surpassed the company’s guidance of 95-99 cents and the Zacks Consensus Estimate of $1.01. Earnings also improved 26.8% from 82 cents reported in the prior-year period.

Ross Stores, Inc. Price, Consensus and EPS Surprise

Ross Stores, Inc. Price, Consensus and EPS Surprise | Ross Stores, Inc. Quote

Total sales rose 8.9% to $3,737.9 million and beat the Zacks Consensus Estimate of $3,664 million, driven by 5% increase in comparable-store sales (comps). Notably, sales and comps growth surpassed the company’s projected rise of 5-6% and 1-2%, respectively. Comps growth can primarily be attributed to the rise in traffic and increased average basket size.

Cost of sales increased 10.2% to $2,667 million and 80 basis points (bps) as a percentage of sales. The improvement was driven by 15 bps increase in merchandise margin, 5 bps decline in buying costs and 15 bps leverage in occupancy expenses. However, these were partly offset by 85 bps increase in distribution expenses and 30 bps impact from higher freight costs. Selling, general and administrative expenses increased 30 bps due to higher wage-related costs, as well as the absence of 20 bps legal proceeding-related gain, which occurred in the second quarter of fiscal 2017.

Operating margin contracted 110 bps to 13.8% as higher freight costs, wage-related investments and unfavorable timing of pack away-related expenses more than offset gains from higher merchandise margins, and leverage on occupancy and buying costs. However, operating margin outperformed the company’s expectation of 13.3-13.5%.

Store Update

Ross Stores remains on track with its store expansion plans, which is clear from the 22 Ross and eight dd’s DISCOUNTS store openings in second-quarter fiscal 2018. With this, the company is poised to reach the target of opening 100 stores in fiscal 2018, which includes 75 Ross and 25 dd’s DISCOUNTS stores. This guidance does not include the company’s plans to close or relocate nearly 10 older stores.

In the fiscal third quarter, the company plans to open nearly 40 stores, including 30 Ross and 10 dd’s DISCOUNTS.

As of Aug 4, 2018, Ross Stores operated 1,680 outlets, including 1,453 Ross Dress for Less stores and 227 dd's DISCOUNTS stores.

Further, the company’s focus on store expansion is highlighted by its recent research, which suggests that it has the potential to increase penetration in the existing as well as new markets. Consequently, it raised the long-term projected store growth target to 3,000 from the prior guidance of 2,500. This will include the opening of nearly 2,400 Ross Dress for Less stores (up from the prior forecast of 2,000) and 600 dd’s DISCOUNTS stores (up from the prior assessment of 500).

Financials

Ross Stores ended second-quarter fiscal 2018 with cash and cash equivalents of $1,386.9 million, long-term debt of $312.2 million and total shareholders’ equity of $3,184.6 million.

During the reported quarter, the company bought back 3.2 million shares for $273 million. Year-to-date, the company has repurchased 6.5 million shares for nearly $529 million. It remains on track to repurchase shares worth $1.075 billion in fiscal 2018. Additionally, it approved a quarterly cash dividend of 22.5 cents per share. The increased dividend is payable on Sep 28 to shareholders of record as of Sep 13.

Guidance

Ross Stores projects strong multi-year sales comparisons in the fiscal third and fourth quarters. Consequently, it anticipates comps growth of 1-2% in both the fiscal third and fourth quarter. Backed by the comps growth, earnings per share is expected to be about 84-88 cents (versus 72 cents in the year-ago quarter) in the fiscal third quarter and $1.02-$1.07 (compared with $1.19 in the year-ago quarter) in the fiscal fourth quarter.

Other assumptions for the fiscal third quarter include sales growth of 5-6%. The company projects operating margin to be 11.9-12.1%, reflecting a decline from 13.3% in the year-ago quarter. This decline is mainly attributed to expectations of ongoing pressures from higher freight and wage investments, alongside slight deleverage in occupancy and other expenses. Net interest income is estimated at about $2 million while the tax rate is expected to decline to nearly 23-24%.

Based on the first-half results and the second-half view, the company raised earnings outlook for fiscal 2018. It now projects earnings per share of $4.01-$4.10 for fiscal 2018 compared with the previous guidance of $3.92-$4.05 and $3.55 per share reported in fiscal 2017. Comps for fiscal 2018 are estimated to increase 1-2%.

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