Shares of off-price retail giant Ross Stores (NASDAQ:ROST) slumped about 6% on Wednesday, following the company's fourth-quarter earnings report. While sales and earnings per share came in ahead of expectations last quarter, investors were disappointed with Ross Stores' cautious outlook.
It's true that the company will face tough year-over-year sales comparisons in fiscal 2018. It will also need to overcome a big cost headwind from planned wage increases. Nevertheless, Ross Stores' guidance is probably extremely conservative -- as usual. As a result, this looks like a great opportunity to invest in a company with a terrific long-term growth trajectory.
Earnings and guidance by the numbers
Last week, No. 1 off-price retailer TJX Companies (NYSE:TJX) reported that sales trends rebounded in the fourth quarter following bouts of weakness earlier in the year. Comp sales rose 4%, driving a 16% EPS increase on an organic basis. Looking just at TJX's domestic business -- as Ross Stores doesn't operate any stores outside the U.S. -- comp sales and segment income both increased 3% last quarter.
In keeping with recent trends, Ross Stores outperformed its larger rival by a wide margin during the fourth quarter. It posted a strong 5% comp sales increase. Furthermore, total sales rose by 16%, a result of having more stores in operation and an extra week in the fourth quarter.
As a result, adjusted EPS reached $0.98, up from $0.77 a year earlier. Excluding the benefit of the extra week, Ross Stores' EPS increased 14% for the quarter and for the full year.
Looking ahead to fiscal 2018, management projects that comparable-store sales will increase 1%-2%. Based on this sales forecast, adjusted EPS would probably reach $3.86-$4.03, up from $3.24 in fiscal 2017, excluding earnings from the extra week. Virtually all of this projected EPS growth comes from the recent reduction in the corporate tax rate.
Guidance is always conservative
In conjunction with its earnings release, Ross Stores announced that it will increase its minimum wage to $11 an hour this year. That will put it a step ahead of TJX, which is taking a market-by-market approach to wage increases in 2018.
Paying higher wages should enable Ross Stores to recruit and retain good employees. However, management warned investors that the company's operating margin will deteriorate as a result.
Yet this isn't the first time Ross Stores has raised its wages or faced other cost headwinds. If the company can surpass its sales guidance, it should be able to offset much, if not all, of its expected margin pressure this year.
That's exactly what investors should expect. Fiscal 2017 was the third consecutive year for which Ross Stores posted a 4% full-year comp sales increase. It began each of those years with a forecast for 1%-2% comp sales growth. The company also exceeded the high end of its initial full-year EPS guidance by 4%-6% each time.
U.S. consumer confidence recently reached a 17-year high. If anything, Ross Stores should be able to beat its initial guidance by even more than usual in 2018.
An inexpensive stock with high growth potential
Based on Ross Stores' pattern of routinely beating its guidance, a "fair" estimate of its 2018 EPS power might be $4.20-$4.25. That would imply that the stock trades for less than 18 times forward earnings, roughly in line with the market average.
However, Ross Stores stock deserves to trade at a solid premium to the market. The company has routinely delivered double-digit EPS growth for many years, and it expects to continue doing so for the foreseeable future. Management sees room to expand the store count by more than 50% -- and that is also probably a conservative estimate. Thus, investors who buy the stock now are likely to reap big gains in the next five years.
Adam Levine-Weinberg owns shares of The TJX Companies and is long January 2019 $50 calls on Ross Stores and short January 2019 $90 calls on Ross Stores. The Motley Fool recommends The TJX Companies. The Motley Fool has a disclosure policy.