Investors in Ross Stores (NASDAQ:ROST) were very pleased with the company's second quarter results. The strong results and the solid guidance for the rest of the year resulted in investors cheering on the final trading day of the week.
Given the strong track record, the continued growth and the modest valuation, I remain cautiously optimistic and am a buyer on dips.
Highlights For The Second Quarter
Ross Stores reported second quarter sales of $2.73 billion, a 7.0% increase compared to the year before. Revenues came in ahead of consensus estimates at $2.70 billion.
Reported GAAP earnings were up by 12.4% to $239.6 million. Thanks to share repurchases, Ross managed to report an even steeper increase in earnings per share which rose by 16.3% to $1.14 per share.
Adjusted earnings of $1.12 per share, which exclude a one-time benefit of two pennies per share, came in four cents ahead of consensus estimates.
What Is Driving Growth?
Ross is benefiting from a steady increase in sales thanks to new store openings, while comparable sales were up by 2% as well. This resulted in the performance coming in at the high end of expectations with customers responding well to the assortment of bargains, according to CEO Barbara Rentler.
Traditionally Ross Stores has relatively low gross margins which came in at 28.8% of sales. This marked a roughly 30 basis points improvement compared to the year before. At the same time the company managed to reduce operating expenses by 40 basis points to 14.5% of sales on the back of lower legal expenses, among others.
Comforting Outlook For The Rest Of The Year
For the current quarter, earnings are seen between $0.83 and $0.87 per share which compares to last year's earnings of $0.80. Investors have been looking for earnings of $0.86 per share.
Fourth quarter sales are seen between $1.05 and $1.09 per share which translates into a full year earnings guidance of $4.18 to $4.26 per share. Previously, Ross guided for earnings of $4.09 to $4.21 per share with analysts looking for earnings of $4.21 per share.
Underlying the earnings guidance is anticipated comparable store sales growth of 1-2% for the final two quarters of the year.
What About The Valuation?
At the end of the quarter, Ross held some $550 million in cash and equivalents while having just $150 million in debt, resulting in a comfortable net cash position of some $400 million.
With nearly 210 million shares outstanding on a diluted basis at the end of the quarter, equity in the business is valued at $14.7 billion at $74 per share. This values operating assets of the business at some $14.3 billion.
On a trailing basis, the company has posted sales of nearly $10.6 billion and earnings of around $875 million. This values operating assets at 1.4 times annual revenues and 16-17 times annual earnings.
Ross Stores has shown impressive revenue growth over the past decade. Sales have increased by a factor of 2.5 over the past decade, increasing from $4.3 billion to $10.6 billion on a trailing basis, thereby growing at an average rate of 10% per annum.
Earnings have roughly five-folded as the company has doubled its net profit margins at the same time. As a matter of fact, investors have benefited from the fact that the company has retired roughly 30% of its shares outstanding over the same time period.
Back in May, Ross Stores gave a presentation to its investors. The off-price apparel and home fashion business outlined some long term ambitions. The company targets some 2,500 US locations in the long run, a significant increase compared to the current store base of 1,338 stores which represents net 85 stores being opened over the past year.
Implications For Investors
Back in May when the company posted its first quarter results, I last had a look at the prospects for the company. At the time investors were already trading a bit cautious amidst comparable store sales growth slowing down to just 1%.
The concept of ¨Dress For Less¨ is appealing to consumers with notably the lower class and middle-class being under continued pressure in terms of their disposable income despite the stronger economy. To those consumers, high discounts on apparel and home goods are appealing, driving traffic into the company's stores.
As such Ross Stores is very well positioned to report very steep operating margins for a retailer. This is despite having relatively low gross margins. Of course this is the result of strong turnover ratios and a very disciplined approach to inventory management.
At the time I was hoping to pick up shares at around $60 at some point in time, yet shares have only seen lows of $62 in July, just missing my entry target. These strong results and recent retail momentum has pushed shares up nearly 20% ever since to $74 at this moment. I continue to like shares in the $60-$64 region, reflecting the improved operations at the moment, hoping for a nicer entry point in the coming months.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.