Morningstar | 3Q Profitability Challenges at Ross Do Not Surprise; Long-Term Outlook Intact
We do not plan a large change to our $78 per share fair value estimate for narrow-moat Ross Stores after it posted third-quarter earnings. Our reaction is more muted than the shares' 9% dip, as we had a fairly tempered short-term outlook. Despite the results, our long-term view is favorable, calling for mid-single-digit top-line growth and low-teens operating margins, on average, over the next decade. However, we suggest investors await a more attractive entry point before building a position.Ross posted 7% third-quarter revenue growth based on 3% comparable-store sales expansion against a 12.4% operating margin. Management revised its fiscal 2018 EPS guidance to $4.15 to $4.20 from its earlier $4.01 to $4.10; our $4.13 pre-announcement mark lags the new range.
While comparable-store sales lagged TJX's Marmaxx division (7%), Ross faced a more difficult comparison (4% prior-year third-quarter comparable-store sales growth versus Marmaxx's 1% dip). Like its rival, wages and freight weighed on profitability, factors we expect to persist. Despite the cost pressure, Ross' management team indicated it expects a competitive holiday shopping season. We concur, expecting digital and physical retailers to continue to use promotions to drive traffic through the season (and longer term). However, we believe Ross is well-positioned for such an environment. We contend that its agile merchandising operation and treasure-hunt-oriented store experience allows it to refresh its assortment faster than full-price retailers. This approach, which necessitates nimble infrastructure that offers vendors maximum flexibility, should allow Ross to drive store traffic despite the proliferation of alternative sellers. As a partner of choice for vendors looking to sell excess inventory discreetly, we contend that Ross should continue to capitalize on the full-price channel's long-term woes, leading to returns on invested capital that should remain near its mid- to high-20s historical average.
Ross Stores and its subsidiaries operate two brands of off-price retail apparel and home fashion stores, which are Ross Dress for Less? (Ross) and dd's DISCOUNTS?. Ross provides name brand and designer apparel, accessories, footwear, and home fashions for the entire family at savings of 20% to 60% off department and specialty store regular prices every day. dd's DISCOUNTS provides name brand apparel, accessories, footwear, and home fashions for the entire family at savings of 20% to 70% off moderate department and discount store regular prices every day. Both of the company's Ross and dd's DISCOUNTS brands target women and men between the ages of 18 and 54.
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