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Shares of Ross Stores (ROST), the operator of off-price apparel and home fashion stores, announced its second quarter results on Thursday. Shares ended the week 3.5% higher on the back of the announcements.

Second Quarter Results

Ross Stores reported second quarter revenues of $2.34 billion, up 12% compared to last year. On average, analysts expected the company to report revenues of $2.33 billion. Revenues were driven by comparable sales growth of 7%. Net earnings rose 23% to $182.0 million. Earnings per share rose 27% to $0.81 per share, in line with the company's guidance of $0.80-$0.81 per share.

Operating margins improved by 110 basis points to 12.8%, due to incremental improvements in gross margins and a reduction in selling, general and administrative expenses.

The company repurchased 3.7 million shares for an aggregate value of $224 million during the first six months. The company remains on track to execute $450 million in buybacks for the full year of 2012.

Chairman and CEO Michael Balmuth commented on the results:

"We are pleased with our better-than-expected results for the second quarter and first six months 2012. Our strong sales and earnings growth for both periods continues to be driven by our ability to deliver compelling name brand bargains to today's value-focused consumers while strictly controlling both inventories and expenses."

Outlook

For the third quarter, Ross Stores anticipates same store sales growth of 3-4%. Earnings per share are expected to come in between $0.63-$0.66. This compares to last year's earnings of $0.63, which were boosted by lower tax rates. Excluding the tax benefit, last year's earnings came in at $0.57. The guidance comes as a disappointment to analysts, who expected Ross Stores to guide for earnings of $0.70 per share.

For the final quarter of 2012, the company anticipates same store sales up 1-2% compared to last year. Earnings per share are estimated at $0.99-$1.04 for the fourth quarter. Earnings are boosted by a $0.08-$0.09 benefit, from the fact that 2012 has 53 weeks.

The company raised its full year earnings forecast from $3.26-$3.27 towards $3.36-$3.44 per share. This represents a 14 to 17% increase in annual earnings per share. The guidance comes slightly below analysts' forecasts of $3.45 per share.

Valuation

Ross Stores ended its second quarter with $723 million in cash and equivalents. It operates with $150 million in long term debt, for a net cash position $573 million. For the first six months of 2012, the company reported revenues of $4.7 billion, driven by robust same store sales growth of 8%. Earnings rose to $390.6 million, or $1.74 per share.

The company is on track to report annual revenues of $10 billion and earnings of $800 million, or $3.40 per share. The market currently values the operating assets of Ross Stores at around $15 billion. This values the firm at 1.5 times annual revenues, or 20 times annual earnings.

The valuation compares to a revenue multiple of 1.5 for TJX Companies (TJX) and 1.2 times for The GAP (GPS). These competitors trade at 20 times trailing annual earnings.

Currently, Ross Stores pays a quarterly dividend of $0.14 per share, for an annual dividend yield of 0.8%

Investment Thesis

Year to date, shares of Ross Stores have returned over 45%. Shares steadily drifted upwards from $50 in the beginning of the year to levels around $70. Shares are trading at all time highs now.

Shares have returned 400% over the past five years. Results were driven by double digit revenue growth in each of the past years. In the meantime, operating margins increased from roughly 8% to 12%. Revenue growth and margin expansion resulted in a double whammy for earnings growth. Between 2008 and 2011, earnings rose from $1.16 to $2.86 per share.

Long term shareholders have had a great run. Shareholders enjoyed the run, driven by earnings growth and increased valuation multiples, boosting the stock price. Operating performance is still very strong, despite a slowdown in comparable sales growth.

The company is likely to provide excellent returns for its shareholders in the medium to long term future. The "squeezed" middle class is likely to continue to search for bargains.

I remain on the sidelines, as I foresee few triggers for a short term outperformance.

Source: Ross Stores: Strong Operational Performance Drives Shares To Another All-Time High