Ross Stores Inc (ROST) — Q4 2023 Earnings Call Transcript

Good afternoon. Joining me on our call today are Michael Hartshorn, Group President, Chief Operating Officer; Adam Orvos, Executive Vice President and Chief Financial Officer; and Connie Kao, Group Vice President, Investor Relations. We'll begin our call today with a review of our fourth quarter and 2023 performance followed by our outlook for 2024. Afterwards, we'll be happy to respond to any questions you may have. As noted in today's press release, we are pleased with our fourth quarter sales and earnings results that were well ahead of our expectations. Our above-plan sales were driven by our customers' positive response to the improved assortments of quality branded bargains throughout our stores. Earnings per share for the 14 weeks ended February 3, 2024, were $1.82, up from $1.31 per share for the 13 weeks ended January 28, 2023. Net income for the period rose to $610 million versus $447 million last year. Sales for the fourth quarter of 2023 grew to $6 billion, driven by robust comparable store sales gain of 7%. For the 2023 fiscal year, earnings per share were $5.56, up from $4.38 for the 52 weeks ended January 28, 2023. Net income for the fiscal 2023 was $1.9 billion compared to $1.5 billion last year. Total sales for the year increased to $20.4 billion, up from $18.7 billion in the prior year period. Comparable store sales for the 52 weeks ended January 27, 2024, grew a solid 5%. As noted in our press release, the sales results for both the 2023 fourth quarter and fiscal year included a $308 million benefit from the 53rd week. Earnings per share for both periods also benefited from the extra week by approximately $0.20 per share. Fourth quarter operating margin grew 165 basis points to 12.4%, up from 10.7% in 2022. This improvement was mainly due to the strong gains in same-store sales and lower freight costs that were partially offset by higher incentives. The 53rd week also benefited operating margin by 80 basis points. Now let's turn to additional details on our fourth quarter results. For the holiday selling season, cosmetics, home and children's were the best-performing merchandise areas, while geographic results were broad-based. dd's discount sales trends slightly trailed Ross' growth. While dd's top line results were respectable in fiscal 2023, we are disappointed with the performance in newer markets. We are currently conducting an in-depth analysis of dd's to better understand and address the different wants and needs of their diverse customer base, particularly as we expand outside our current existing geographies. Until this work is completed, we believe it is wise over the near term to moderate dd's store growth in newer markets and focus new store openings, primarily in existing regions. Now let's turn to inventory. As we ended the quarter and the year, consolidated inventories were up 8%. Average store inventories were up 9% compared to 2022's holiday period due primarily to the 53rd week shift. Packaway represented 40% of total inventories similar to last year. Regarding our store expansion program, we added 94 net new stores in 2023, including 71 Ross Stores, Ross Dress for Less and 23 dd's DISCOUNTS. We ended 2023 with 2,109 stores, including 1,764 Ross Dress for Less and 345 dd's DISCOUNTS locations. As we noted in today's release, for the fourth quarter and fiscal 2023, we repurchased a total of 1.9 million and 8.2 million shares of common stock, respectively, for an aggregate purchase price of $247 million in the quarter and $950 million for the fiscal year. These purchases were made pursuant to the 2-year $1.9 billion program announced in March 2022, which we have now completed as planned. Our Board of Directors also recently approved a new 2-year, $2.1 billion stock repurchase authorization or approximately $1.05 billion for each fiscal year. This new plan represents an 11% increase over the recently completed repurchase program. In addition, the Board approved a 10% increase in our quarterly cash dividend to $0.3675 per share to be payable on March 29, 2024, to stockholders of record as of March 15, 2024. The increases to our stock repurchase and dividend programs reflect our continued commitment to enhancing stockholder value and returns, given the strength of our balance sheet and our ongoing ability to generate significant amounts of cash after funding growth and other capital needs of business. Now Adam will provide further details on our fourth quarter results and additional color on our outlook for fiscal 2024.

Thank you, Barbara. As previously mentioned, comparable store sales rose a strong 7% for the quarter, entirely driven by higher traffic and shoppers positive response to our improved assortments throughout our stores. As Barbara noted earlier, fourth quarter operating margin of 12.4% was up 165 basis points from 10.7% in 2022 and included about an 80 basis point benefit from the 53rd week in 2023. Cost of goods sold as a percent of sales improved by 265 basis points versus last year, benefiting from a combination of factors. Merchandise gross margin increased by 110 basis points, primarily due to lower ocean freight costs. Distribution costs declined by 75 basis points partially driven by favorable timing of packaway-related costs. Domestic freight and occupancy costs levered by 75 and 45 basis points, respectively. Partially offsetting these benefits were buying costs that increased 40 basis points, mainly from higher incentives. SG&A for the period delevered by 100 basis points, mostly driven by higher incentive costs and wages. Now let's discuss our outlook for fiscal 2024. As mentioned in our press release, we are encouraged by the sustained sales momentum that began in the second quarter of 2023 and continued through the holiday season. That said, there remains ongoing uncertainty in the macroeconomic and geopolitical environments. In addition, while inflation has moderated, prices for necessities like housing, food and gasoline remain elevated and continue to pressure the low to moderate income customers' discretionary spend. While we hope to do better, we believe it is prudent to continue to take a conservative approach to forecasting our business in 2024. For the 52 weeks ending February 1, 2025, we are planning comparable store sales to increase 2% to 3% on top of a solid 5% gain in 2023. If sales perform in line with this plan, we expect earnings per share for 2024 to be in the range of $5.64 to $5.89 compared to $5.56 in fiscal 2023. As a reminder, fiscal 2024 is a 52-week year compared to 53 weeks in 2023. As previously mentioned, our 2023 earnings per share benefited from an additional $0.20 of EPS from the extra week. Turning to our guidance assumptions for the 2024 year. Total sales are planned to grow by 2% to 4% for the 52 weeks ending February 1, 2025, versus the 53 weeks ended February 3, 2024. This year-over-year increase in total revenue is affected by last year's 53rd week, which added approximately $308 million to sales in the fourth quarter and fiscal year of 2023. If same-store sales perform in line with our plan, operating margin for the full year is expected to be in the range of 11.2% to 11.5% compared to 11.3% last year, which benefited by 25 basis points from the 53rd week. This year-over-year change also includes the benefit of anniversarying higher incentive costs in 2023, given our outperformance. In addition, for fiscal 2024, we expect merchandise margins to be pressured as we plan to offer even more brands that are sharply priced to deliver the strong value proposition that our customers expect from us. For 2024, we expect to open approximately 90 new locations, comprised of about 75 Ross and 15 dd's DISCOUNTS. These openings do not include our plans to close or relocate about 10 to 15 older stores. Net interest income is estimated to be $143 million. Depreciation amortization expense inclusive of stock-based amortization is forecast to be about $610 million for the year. The tax rate is projected to be about 24% to 25% and diluted shares outstanding are expected to be approximately $332 million. In addition, capital expenditures for 2024 are planned to be approximately $840 million as we make further investments in our stores, supply chain and merchant processes to support our long-term growth and to increase efficiencies throughout the business. Let's turn now to our guidance for the first quarter. We are planning comparable store sales for the 13 weeks ending May 4, 2024, to be up 2% to 3% versus a 1% gain in last year's first quarter. If sales perform in line with this range, we expect earnings per share for the first quarter of 2024 to be $1.29 to $1.35 versus $1.09 last year. The operating statement assumptions that support our first quarter guidance include the following: total sales are planned to be up 6% to 8% versus last year's first quarter. We would then expect first quarter operating margin to be 11.1% to 11.4% compared to 10.1% last year. The expected increase mainly reflects our forecast for lower incentives and freight costs that are partially offset by lower merchandise margin and higher wages. We plan to add 18 new stores consisting of 11 Ross and 7 dd's DISCOUNTS during the period. Net interest income is estimated to be $44 million. Our tax rate is expected to be approximately 24% to 25% and diluted shares are forecasted to be about $335 million.

Thank you, Adam. To sum up, as Adam noted, while we hope to do better than our forecast this year, the external environment remains uncertain and our low to moderate income customers' discretionary spend continues to be impacted by elevated cost of living. Despite these headwinds last year, our shoppers responded positively to the strong values we offered across our stores which drove our better-than-expected sales and earnings growth throughout 2023. In 2024, we plan to build upon these efforts and offer even more brands that are sharply priced to deliver the strong value proposition that our customers expect from us. We believe the diligent execution of this plan will result in increased market share gains this year and in the future. At this point, we'd like to open the call and respond to any questions you may have.

Barbara, I was hoping to better understand the dynamic around the sharply priced brands and their impact on merchandise margins. How large of a percentage of the assortment were you planning to take down to these sharper price points? And is there other opportunity to improve on the gross margins through domestic freight or other line items as the year progresses?

Sure, Lorraine. So let's talk about the sharply priced brands. Obviously, I wouldn't disclose what type of penetration we're going to shift to. What I would say about the sharply priced brands is that during '23, we strengthened our value offerings. We kept saying that we were doing that, and we were doing that. And that really resulted in the acceleration of sales which started in Q2 and persisted through the whole holiday season. That's how we came up with in 2024, that we planned to build upon those successes we had in '23 by offering more brands that are sharply priced to deliver that value proposition the customer wants. It's a tiered strategy; a good, better, best strategy. So in terms of gross margin expansion from the pure merchandising side, we really believe this will drive sales and market share. The customer has been voting on this all year, and we feel like it's a strategy that's broad-based in the entire box. Certainly, there are some businesses that have more opportunities than others. But that's really how we came to this conclusion.

Lorraine, then on just the other margin opportunities from a freight standpoint, we do expect to see some improvement for the full year, but to a lesser extent than we saw last year.

And congrats on another great quarter. So Barbara, I guess maybe could you elaborate on drivers that you think really were behind? I think this is the best fourth quarter performance in more than 10 years, if I exclude the pandemic. Maybe what you saw across categories, do you think that you're attracting a new customer? And maybe just the decision to raise your initial comp view for 2024 to the 2% to 3% relative to historical 1% to 2%? And then just one for Adam. Any change to bottom line flow-through in the model for 2024 as we think about incremental comp potential upside?

It's Michael Hartshorn. Just on the customer overall. It's hard to see whether it's a new customer or if the existing customer is spending more. What we saw is our performance was broad-based across region and across all aspects of our business, including geographically, income levels and age.

In terms of the drivers, the categories, the ones I said, cosmetics, home and children's were really the best, Accessories was slightly above the chain and apparel trailed the chain. But again, it performed above our plan. I think part of the things that really drove it was we had a big push this year in home on gifting, and we added some new classifications, and the customer responded.

And on the flow-through question, this is Adam. Nothing has changed. We expect EBIT margin flow-through of about 10 to 15 basis points for each additional point of above-plan sales. With our guide of plus 2% to 3%, you see margin rate expansion. We're getting some benefit also this year of lower incentive costs based on our outperformance from 2023.

Maybe first, Barbara, just any hypothesis on what might be driving the weaker-than-expected dd's performance in newer markets? And maybe comment also on how the Ross Dress for Less stores in newer markets have been performing relative to your expectations?

I'll start with Ross. The new markets for Ross have been performing at or above our expectations. In terms of dd's, as mentioned in the commentary, the overall comparable sales were slightly below Ross for both the quarter and the year. While the overall comps were respectable, we have been disappointed with the performance of dd's in new markets. Our new markets tend to be more diverse in terms of ethnicity and income, and we clearly did not meet their needs with the assortments we have been offering.

Maybe just a follow-up. Can you comment on the buying environment and any changes you're seeing? And how is that impacting the expectations for the merchandise margin pressure this year, if at all?

Well, I think it's a positive buying environment. I mean there's still merchandise in the market. And I've said this on calls before, there are some vendors that are very aggressive in bringing in inventory as they're trying to gain market share and then others, it's more normalized. In terms of merchant margin, our strategy now is really to continue to offer the customer really great value because that is really, really what's working sharp prices. Even if you're buying some of these really great opportunities, we are really thinking about passing along really that potential savings to the customer because we really do believe that is the best way to gain market share.

Great results. From a category perspective, which categories do you view as the biggest opportunities in 2024? And curious, separately what you're seeing on the shrink front in the quarter and what your expectations are for '24? A couple of retailers, including Target today have called out improving shrink results lately.

Sure. In terms of categories for 2024, with the brand strategy we're implementing, I see a broad-based opportunity. However, our apparel business has been lagging behind the chain. Therefore, we are focusing on enhancing those assortments to align the apparel business more closely with our other sectors.

Chuck, on the shrink front, I would say we're not immune to the external theft and organized crime environment throughout retail. We do continue to invest in initiatives to hold shortages at bay. For 2023, our shrink levels were in line with 2022. Our guidance assumes that shrink is up a bit. So that's built into the guidance, but we'll continue to make investments there to keep it in line.

Congrats on a really nice holiday. And I apologize if you said it, but did you mention how much the extra week impacted the gross margin in the fourth quarter? I heard the operating margin, but just housekeeping on that. And then, I guess, maybe we could talk a little bit about how you built to the comp guidance for the year with the 2% to 3% comp in the first quarter and in the year? I guess, as the comparisons get a little tougher, I think it implies the 2-year accelerates a little bit as we move through the year. Anything you could point to help us think alongside you on that, please?

Sure. From the merchandise strategy, we do expect it to accelerate as we go. We've been building the strategy starting in Q2 of 2023. Now it's more broad-based than we were originally. It's become more intentional in certain businesses than it was before. We do expect that our apparel business as we move through the year will improve.

On the 53rd week question, we thought operating margin was worth 80 basis points in Q4 and about 25 for the year, and that was largely in gross margin versus SG&A.

Perfect. Super amazing. It looks like you guys are further closing the gap to pre-COVID EBIT with every passing quarter, even though the fourth quarter still sits somewhat below. Can you just talk about what's hampering you from returning to the pre-COVID levels and how you think about recovering that gap from here? And then maybe Barbara, a big picture question for you. What are your key priorities for the year as you think about Ross?

On the long-term kind of what it's going to take to close the EBIT margin gap. Obviously, the biggest drivers are where wages and freight have been over the last couple of years. We believe we can achieve gradual improvement in profitability. As always, EBIT growth will be highly dependent on sustained strong sales growth. The improvements we've made and continue to make to strengthen our value offerings will lead to market share gains in the long run. I'll also say we're investing in capabilities to drive efficiencies and cost savings that we believe will contribute to profitability as well over time. As you can see in this year's guidance, our EBIT leverage is around 3% with double-digit EPS growth at the top end of that 2% to 3% range on a 52-week basis. Over the long term, we think we can get leverage in the 3% to 4% comp range.

In terms of priorities, our priority this year is really to gain market share through a diligent execution of the strategy. We've done a lot of work around what we believe we need to do to gain market share. So on the Ross side, that really is my key priority. Then on the dd's side, we need additional insights to understand the customer so we can better satisfy her needs as we enter newer markets.

Great. And let me add my congratulations as well. Barbara, on the dd's, I was wondering if you could talk about the new store strategy? Are you clustering them? What regions outside of California or is it within kind of the West Coast are seeing the differences? Any more detail on your early thoughts on what's happening there other than the broader demographic mix?

Our real estate strategy for dd's is a little different than Ross. It's not as clustered. There are distinct ethnic differences outside of our core markets in Texas, Florida and California, which means we have to find the right assortment that's different from our core markets. We'll know more after we go through the customer research, and then we'll start making the adjustments we need to improve performance.

On the transaction, our 7% comp was all driven by traffic. The average basket was flat. So we had slightly higher AUR and slightly lower items per transaction.

I was hoping you could elaborate on the assumptions embedded in your outlook for SG&A expense for the year. What are you assuming for wage and other investments? And what are you seeing in the wage environment currently?

I would say it's somewhat stabilized. Really where we're taking wage increases is where required by the minimum wage changes state by state. From an SG&A standpoint, we'll get the benefit of anniversarying the higher incentive costs. We've done a good job while the minimum wage changes are putting pressure in the stores. Through some of the efficiencies we've invested in, we've been able to offset that. So I'm not seeing much overall pressure on the store side.

Michael, maybe to you, I think to answering your question earlier, you had said you expect freight to be a benefit this year but less so than in '23. Were you referring to domestic freight specifically? Are you talking to freight, including ocean freight within the merchandise margin?

In that one, I was talking about domestic freight, but I'll let Adam take it from here.

On the ocean freight side, we'll get a little benefit in Q1, but negligible over the course of the year. Obviously, this is dependent on how the situation plays out in the Suez Canal and the duration of that conflict if anything changes. But I would also say that impacts a very small portion of our freight, yet we're closely monitoring that situation. On the domestic side, that's what Michael was commenting on earlier because fuel prices are lower than where they were at least this time last year. Based on our contracted rates, we should see some slight benefit throughout the year on the domestic side.

Great job. I apologize if I missed it, but did you mention if any of the increased transactions or traffic reflect a benefit from customers trading down? Additionally, I hope this isn't too naive a question, but does the presence of sharply priced brands have any impact on your situation, or is it primarily creating a better value proposition without affecting average unit revenue?

On the trade down customer, it's hard to see whether there's a trade-down customer performance. It was broad-based overall, across geographies, but it was also broad-based across income levels. Hard to tease out any impact from the trade-down. The comp was entirely driven by transactions for us. The average basket was flat with slightly higher average unit retails offset by slightly lower units per transaction. The weather front was neutral for us.

The AUR fluctuates based on the mix and the value of the goods that we're buying. There's not a specific AUR pricing strategy. It's really a value strategy as we buy goods and put them at the sharpest price possible to offer great value. So it's not like we're aiming for a specific AUR. It could move as we go through the year and as we encounter different closeouts and products, we're expecting it to fluctuate.

At dd's, I'm curious how many stores are in region where you considered disappointing and what percentage of the store base do they represent? I'm curious if they didn't open as strongly as you thought? Or are they not comping as quickly as you thought? And also curious how the Ross Stores are performing in those same regions?

There are certain stores outside of our core markets. As far as Ross, Ross is performing well in these markets, but it's really about how they opened. Some of them are comping well, but they're comping off a low sales base.

So we talked about, Paul, 10 to 15 either relocated or closing stores, and we won't get into Ross versus dd's on that front.

Nor have we decided yet. Usually, these are stores, as you know, that are at the end of the lease term or starting a new option period where we'll make that judgment as we progress through the year.

Congrats on a really nice quarter. I'm going to hop in on the pricing question. I want to clarify the sharp price pricing because it sounds like Barbara, you're thinking about this a little bit more holistically, sort of getting to a better balance of really sharp opening prices and then layering that next level and the next level, versus looking at what you purchased and maybe taking a shorter margin here and longer margin there. Is that right?

Whenever you're pricing goods, you're always looking at the product and the value. The sharp pricing we're talking about is really adding more brands at all three levels, good, better, best, assessing those brands and then putting them out at values that the customers responded to. It's really built on the products themselves.

I have two questions. I'm curious about the cadence of comps through the quarter, particularly coming out of holiday into January and where you were exiting the quarter. The other is on stores. You talked about initiatives in the stores, and you've discussed it for the last couple of quarters. Do you see more structural benefits to store size margins over the next year or so from the store initiatives that you've been rolling out?

On both of those, we typically don't talk about inter-quarter trends. On a stack basis, comps were slightly stronger during the peak holiday selling period. On the 4-wall margin, we are making investments in stores to improve efficiencies. These investments are offsetting some of the minimum wage increases. We're also piloting self-checkout and using more efficient handheld devices in our stores to help manage tasks.

Congratulations on the very nice results. As you think about the store profile in 2024 for both dd's and Ross, any changes in how you're thinking about it in terms of size? Barbara, you've always talked in the past about adding to the merchant team. What does it look like this year in terms of number of buyers or merchants added to the team?

No, we're not thinking of any changes to the store prototype as we move into '24.

In terms of the size of the merchant team, we have over 900 merchants. Every year, we promote or move people. But we're not substantially increasing headcount; it’s a normal cadence. We feel like we have a good sized team between the two companies.

As you went through the quarter in January, we know there were those two weeks that were very cold. Was that an impact for you in the comps and would the comps have been even stronger if you hadn't had that weather issue that happened mid-January?

On the quarter overall, we consider the weather impacts neutral for us.

In the past, you've talked about 60% to 65% new store productivity. Given your comments on dd's, is that a consistent assumption within your guidance for 2024?

That continues to be because the vast majority of the new stores are Ross. That said, we expect the stores we are opening for dd's to be similar to historical sales levels because they're in existing markets. But overall, 60% to 65% of a comp. About 40% of the capital this year is going to expanded capacity. We plan to open a new distribution center in early '25. We're looking at leveraging AI in two parts. We are using AI in automated parts of our business. Generative AI will be a journey for us, but we are looking for efficiencies.

Great job on the holiday quarter. Just going back to stores. Ross Stores banner grew 4% this year. How do we think about store growth not just for fiscal '24, but also beyond that and how that fits into your long-term store targets?

Our long-term store target hasn't changed, that's 2,900 Ross Stores and 700 for dd's. Expect about 100 stores a year. We're comfortable with opening 75 Ross stores annually. There is a lot of competition for our locations. Overall, we feel good about the real estate landscape and have a healthy pipeline.

It looks like you're making a conscious decision to sharply control inventories, to maximize profits and minimize markdowns. Are we reading that right?

We're managing our in-store inventories based on turn, and we set it up. If we can beat the plan, then we can leverage markdowns. That's the way we run the business.

I was curious how that's incorporated into your thinking on comps and maybe where you see some of the biggest opportunities in the first half to take share.

We plan our inventory based on sales and turn, and we build that by business. We know where we can show great value and where we can add assortment. It's a flexible business model, and we have the ability to adjust inventory as we feel necessary based on customer response.

Barbara, you talked that one of your goals for the year was taking market share. Is your expectation that you're going to take market share from other off-price retailers or department stores or maybe just a little bit from everybody?

I just think there's market share to be had. More stores keep closing, and there's just less places for consumers to shop. Our job is to satisfy the customer. And if we do that, there are consumers out there for us to pick up and expand.

Thank you for joining us today and for your interest in Ross Stores.