Last Thursday, Ross Stores (ROST -1.00%) followed top rival TJX Companies (TJX 0.05%) by reporting strong results for the second quarter. Sales and earnings both easily beat analysts' estimates. That said, the off-price retailer issued surprisingly weak guidance for the third quarter. Let's take a look.
Another big earnings beat
In the first quarter, Ross Stores' comparable store sales jumped 13% compared to the first quarter of fiscal 2019, sailing well past management's guidance for a 1% to 5% decrease in comparable sales. The stellar sales performance drove a correspondingly large earnings beat.
Nevertheless, Ross Stores issued a conservative forecast for the second quarter. Management projected that comp sales would rise a modest 5% to 7% compared to fiscal 2019. Moreover, it predicted that wage increases, COVID-19 safety-related expenses, and escalating freight costs would cause Q2 earnings per share (EPS) to fall to a range of $0.80 to $0.89 from $1.14 two years earlier.
Once again, the off-price retailer crushed its guidance, as well as analysts' expectations. Comp sales jumped 15% compared to two years ago -- more than double the pace of growth that management had predicted. That drove a 21% increase in total sales to $4.8 billion.
This impressive sales growth bolstered the company's profitability by allowing it to reduce clearance discounts and spread its operating expenses over more revenue. As a result, EPS surged to $1.39, beating Ross Stores' guidance by more than 50% and topping even the most bullish analysts' forecasts.
While Ross Stores' sales growth and earnings growth accelerated somewhat moving from the first quarter to the second quarter, the company provided a downbeat outlook for the current quarter. Ross Stores again projects that comp sales will rise 5% to 7% compared to fiscal 2019. Moreover, it anticipates severe margin pressure in the third quarter, causing EPS to fall to a range of $0.61 to $0.69 (down from $1.03 two years ago).
Management pointed to a number of factors that could disrupt Ross Stores' momentum in the near term. Most notably, the spread of the delta variant has caused COVID-19 case numbers and hospitalizations to surge in the U.S. recently. That could potentially cause some consumers to cut back store visits. Additionally, the benefit from pandemic-related stimulus programs could fade relative to the first half of fiscal 2021.
Meanwhile, executives expect the margin pressure from soaring freight costs to intensify over the next few quarters. The headwind from wage increases will grow this quarter, too.
Yet even with these potential headwinds, Ross Stores' forecast seems implausibly low. That left many analysts confused about whether management is just being ultra-cautious with its guidance or if management expects results to deteriorate in the near term.
TJX stock looks like a better bet
While Ross Stores is likely to easily beat its guidance for the third quarter and fiscal year, its larger peer TJX may be a better investment. For one thing, TJX posted stronger sales growth in the second quarter, with comp sales soaring 20% compared to two years ago. TJX's exposure to the home furnishings market through its HomeGoods and HomeSense chains has proven to be a major competitive advantage recently.
Despite being more than twice as large as Ross Stores, TJX has ample room for future growth. First, it has successfully introduced new retail concepts over the years, including the outdoor-focused Sierra chain, which has a lot of untapped expansion potential.
Second, TJX has a long track record of successful international expansion. In addition to adding more stores in its existing markets, TJX could use its solid foothold in Northern and Central Europe as a springboard for entering big markets like France, Spain, and Italy. Conquering international markets would be much harder for Ross Stores, which has no experience outside the U.S.
To be sure, Ross Stores also has plenty of long-term growth potential. But with both off-price giants trading at similar earnings multiples and TJX growing somewhat faster right now, TJX stock is the most attractive investment option in the off-price retail sector.