Ross Stores: An Improving Performance Sets the Stage for Long-Term Growth

Ross Stores is down this year, but a sluggish consumer-spending environment in addition to efficient strategies might result in improvements.

Jun 6, 2014 at 12:00PM

According to the U.S. Department of Commerce, consumer spending in the U.S. fell in the month of April for the first time in a year. Apparently, consumer confidence is still not strong, as people are keeping a tight leash on spending. In such circumstances, off-price retailers such as Ross Stores (NASDAQ:ROST) should do well.

This hasn't been the case so far, as Ross is down 8% year to date. It operates in a highly competitive industry where other off-price retailers such as TJX (NYSE:TJX) and retail giants such as Wal-Mart Stores (NYSE:WMT) ply their trades. However, Ross Stores is gradually getting better. Its recent first-quarter results were decent, and the company looks set to come out of its slump going forward.

Getting better
In the first quarter, Ross' revenue increased 6% to approximately $2.7 billion from the prior-year period, while earnings increased 4%. For the second quarter, it expects revenue to increase 5% to 6% year over year. Also, earnings per share for the second quarter are expected to be in the range of $1.05 to $1.09, up from $0.98 last year.

Management has taken measures to control inventory and expenses. This led to Ross' improved earnings performance despite a challenging retail environment. Also, the company seems to be benefiting from warmer weather. According to CEO Michael Balmuth, "Sales trends improved in April with more seasonal spring weather that coincided with the later Easter shopping period."

In addition, the company has been employing a number of strategies to increase sales and improve earnings.

Strategies to drive growth
An important part of Ross' growth is to expand its number of stores. It opened 26 Ross location and seven dd's discount stores in the first quarter. The company plans to open another 22 Ross locations and seven dd's discount stores in 2014. 

Apart from the expansion, management is focused on tightly controlling expenses. Ross' focus on efficient inventory management and distribution has helped it to reduce markdowns and to sell merchandise at the intended prices. As a result, it reduced its selling, general, and administrative expenses by 10 basis points in the first quarter, while distribution costs decreased by five basis points.

These strategies are expected to yield long-term growth for Ross. The company forecasts same-store sales growth of 1% to 2% in the second quarter, which is better than the 1% increase seen in the previous quarter at the midpoint. Also, it expects cost cuts to continue to drive bottom-line growth. Ross posted robust earnings growth despite harsh weather conditions, so as the conditions improve, a better performance can be expected.

Moreover, Ross' off-price business model should lead to an increase in traffic amid a sluggish consumer spending environment. According to management:

We remain confident in the resilience of our off-price business model and our ability over time to successfully execute the proven strategies that have enabled us to deliver solid financial results in both favorable and more difficult climates

Ross is also looking to deliver value to shareholders through share repurchases. In the first quarter, the company repurchased two million shares worth $139 million. It plans to buy back shares worth $550 million in fiscal 2014, which should result in a decreased share count and higher earnings per share. 

What about the competition?
Ross is performing better than off-price rival TJX, which reported weaker-than-expected revenue growth due to negative currency effects. Moreover, TJX also reduced the upper end of its earnings guidance for the fiscal year, while its second-quarter outlook also fell below analysts' expectations.

TJX's performance is in stark contrast to Ross' outlook. However, TJX is investing in supply chain initiatives to offer lower-priced items to customers. The company is timing its inventory purchases so that it can improve its profitability by reducing the ill-effects of markdowns. Moreover, TJX's store expansion plans look ambitious, as the company plans to increase its presence by 60% in markets where it currently operates. 

On the other hand, Wal-Mart is opening smaller stores to capture more market share. Last year, its Wal-Mart Express store concept delivered a same-store sales jump of 5%. Encouraged by this performance, Wal-Mart plans to open between 270 and 300 small stores this year, up from its previous forecast of 120 to 150 stores. This aggressive rollout might prove to be a threat for Ross going forward.

The bottom line
Ross Stores is gradually improving. The company's store expansion plans, proper cost control, and inventory management should enable it to offer competitive prices to customers and to improve profitability. The company's valuation is also attractive at just 17 times last year's earnings. Considering that Ross has a lucrative buyback plan in place and also carries a dividend yield of 1.2%, it might prove to be a good buy.

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Amal Singh has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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