Ross Stores Posts A Strong Second Quarter
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Discount retailer Ross Stores (NASDAQ: ROST) reported strong second quarter results Thursday morning. Revenue grew 12% year-over-year to $2.3 billion, driven by quarterly same-store sales growth of 7%, which was in-line with expectations. Earnings grew 27% year-over-year to $0.81 per share, in-line with the Street’s estimates. Ross provided its typically weak same-store sales guidance, estimating same-store sales growth of 3-4% in its third quarter and 1-2% in its fourth quarter. Management did boost full-year earnings guidance to $3.36-$3.44 from its previous range of $3.26-$3.37. Our fair value estimate remains unchanged.
The firm’s record operating margin of 12.8% shows the company’s commitment to boosting profitability at its existing stores. Increased security, both via greater personnel and technology investments, has helped reduce shrink to what management thinks is nearing the best it can achieve. Though management cited increased transactions as the main driver of same-store sales growth, they also noted increased average transaction sizes. We theorize that pricing may benefit slightly from the weakness in its department store competitors, as well as the shift towards brand names. Interestingly enough, management said approximately 90% of its stores are within 10 miles of a JC Penney (NYSE: JCP) location. While they wouldn’t say Ross is necessarily stealing share from JC Penney, it’s obvious to us that the variance in same-store sales between the two firms suggests that it is stealing share from the beleaguered retailer. Penney's CEO Ron Johnson should fear the intense competition from the discount cohort.
We’re fans of the discount retailer’s business model, and we think it will continue to benefit from shifts in consumer tastes. Competitor TJ Maxx reported similarly strong revenue and profitability growth earlier this week, so we think the retail giants can peacefully coexist. Ross is still in the early innings of its growth plan, as it operates just under 1,100 Ross Stores and believes the market can support an additional 900 outlets. Other than Chicago, Ross has yet to really penetrate the Midwest, and the company hasn’t even started populating the Northeast.
Unfortunately, the competition seems to be intensifying. Nordstrom (NYSE: JWN) recently announced that it intends on doubling the amount of Nordstrom Rack locations over the next five years. We think Rack competes nicely with Ross, though price points are meaningfully higher. Still, the explosive growth of Nordstrom Rack is certainly a threat to Ross' business.
Nevertheless, we'd rather have the Ross business model than that of Kohl's (NYSE: KSS), which we think may be dying. Kohl's same store sales have stumbled really since the fourth quarter of 2010, and we see no reason why the firm will do much better going forward. Kohl's doesn't have brand names, nor does it have the faster time to market that competitors like h&m and Zara exhibit.
Though the company has an additional $450 million left to repurchase shares, we aren’t huge fans of its valuation at current levels. Admittedly, we think the firm has an excellent business model, but competition from TJ Maxx and Nordstrom Rack are heating up. We think shares are slightly overvalued at current levels, but we wouldn’t establish a short position on the firm. Ross is simply executing too well, and the firm’s underlying fundamentals remain strong.
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