Balanced Risk-Reward for Ross Stores (ROST): Prospects Bright

Ross Stores Inc. ROST displayed immense strength, evident from its robust earnings surprise history that benefits from its commitment toward merchandising initiatives, off-price model and store expansion. Driven by these efforts, the company delivered its 13th straight earnings beat in second-quarter fiscal 2019, with positive sales surprise in 11 of the last 13 quarters. Moreover, strength across categories, except for ladies, has been aiding its comps in the past few quarters.

These factors have not only aided the company’s quarterly outcomes but also boosted the share price, which has rallied 30% year to date. However, the recently announced tariffs on goods sourced from China as well as higher operating costs have been denting investors’ sentiment on the stock. These headwinds, which were reflected in Ross Stores’ recent guidance, caused a slowdown in the stock. Consequently, the stock has lagged the industry’s growth of 40.2% in the year-to-date period.

 

Despite the ongoing headwinds, let’s see how well this off-price retailer of apparel and home accessories is placed to boost its stock momentum.

Factors Favoring the Stock

Ross Stores’ off-price model provides strong value proposition and micro-merchandising that drive product allocation and margins. This helped the company deliver solid top and bottom-line trends. Earnings and sales growth in the fiscal second quarter reflected gains from favorable comparable store sales (comps) and better-than-expected operating margin. Further, favorable timing of expenses to the tune of nearly 2 cents per share, which are likely to reverse in the second half of fiscal 2019, aided earnings and operating margin in the second quarter.

Ross Stores’ robust comps trend over the past few quarters, driven by improved performance across categories except for ladies apparel, has been a key growth driver. Notably, comps improved 3% in second-quarter fiscal 2019, driven by slightly higher traffic and increased average basket size. Comps in the quarter also benefited from strength in the men’s category, and the Midwest and Southeast regions.

Despite providing a soft earnings outlook, the company reiterated its sales and comps guidance for the second half of the fiscal year. It continues to anticipate comps growth of 1-2% for the third and fourth quarters of fiscal 2019. Additionally, it estimates witnessing sales growth of 5-6% in the third quarter.

Additionally, the company’s strategy of strengthening its store base has made significant contributions to growth over the years. Its store expansion efforts are focused on continually increasing penetration in the existing as well as new markets.

The company currently operates 1,772 Ross and dd’s DISCOUNTS stores across 38 states, the District of Columbia and Guam. Further, it is on track to meet the target of inaugurating 100 stores in fiscal 2019 — including 75 Ross and 25 dd’s DISCOUNTS outlets. Over the long term, it expects to operate about 3,000 stores, expanding the Ross chain of stores to 2,400 locations while operating about 600 dd’s DISCOUNTS stores.

Factors Hurting Sentiment

Though the aforementioned factors keep us optimistic about the stock’s potential, there remain some hurdles in its growth path. The most prominent among these is the softness in the Ladies category. Further, cost increases on rise in tariffs as well as the higher operating costs, which are hurting margins, remain headwinds.

Ross Stores is witnessing soft performance at the ladies apparel category for the past few quarters. The softness in this category is hurting the otherwise strong comps performance of the company, which is clear from second-quarter fiscal 2019 results. Though comps improved in the reported quarter, ladies apparel continued to remain a drag on comps growth.

However, management noted that the ladies apparel business witnessed slight improvement in the quarter. The company also remains confident that the initiatives undertaken for this category will drive additional gains throughout the rest of the fiscal year. Nonetheless, a full turnaround of this business is unlikely in the near term.

Going into the second half of fiscal 2019, the company anticipates results to bear impacts of the recent announcement of 10% tariffs on goods imported from China, including apparel and footwear. Driven by tariff-related impacts, Ross Stores cut on its earnings view for fiscal 2019 and provided a soft earnings outlook for the second half. It now expects earnings per share of $4.41-$4.50 in fiscal 2019, down from $4.38-$4.52 stated earlier.

Based on the impacts of tariffs, the company expects earnings per share of 92-96 cents for the fiscal third quarter and $1.20-$1.25 for the fourth quarter, whereas it earned 91 cents and $1.20 in the respective year-ago periods.

Alongside tariff-related headwinds, the company expects occupancy and other expense deleverage to put some pressure on the gross margin in the fiscal third quarter, which are likely to result in soft operating margin. It expects operating margin to be 11.8-12% in the third quarter, suggesting a decline from 12.4% recorded in the prior-year quarter.

Wrapping Up

Nonetheless, we see this slowdown in the stock as an attractive entry point as Ross Stores has all it needs to steer through the tough tariff and cost environment. Further, the Zacks Rank #3 (Hold) company’s expected long-term earnings growth rate of 10.4% and a Growth Score of A speak well of its growth potential.

Looking for Better-Ranked Picks? Check These

Burlington Stores, Inc. BURL currently has a long-term earnings growth rate of 15.9% and a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Dollar General Corporation DG, also a Zacks Rank #2 stock, has a long-term earnings growth rate of 11.1%.
 
Target Corp. TGT presently has a long-term earnings growth rate of 7.1% and a Zacks Rank #2.

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