Ross Stores Inc (ROST) — Q1 2024 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 first quarter 2024 results, followed by our outlook for the second quarter and fiscal year. Afterwards, we'll be happy to respond to any questions you may have. As noted in today's press release, though we had hoped to do better, first quarter sales were still in line with our guidance despite macroeconomic headwinds that continue to pressure our customers' discretionary spending. Earnings results for the period were better than expected, primarily due to lower expenses relative to our plan. Total sales grew 8% to $4.9 billion, up from $4.5 billion last year, while comparable store sales rose 3%. Earnings per share were $1.46 on net earnings of $488 million for the 13 weeks ended May 4, 2024. These results compare to earnings per share of $1.09 on net income of $371 million for the 13 weeks ended April 29, 2023. Accessories and children's were the strongest merchandise areas during the quarter while California and the Pacific Northwest were the top-performing regions. dd's DISCOUNTS sales trends in the first quarter were ahead of Ross as shoppers responded favorably to its improved value offering. In the newer markets, we are in the process of updating the assortments to better address the different tastes and preferences of this diverse customer base. We will continue to make ongoing adjustments over time to better position dd's for the future. At quarter-end, total consolidated inventories were up 10% versus last year while average store inventories were up 4% at the end of the quarter due to the 53rd week calendar shift. Packaway merchandise represented 41% of total inventories versus 42% last year. Turning to store growth, we opened 11 new Ross and 7 dd's DISCOUNTS locations in the first quarter. We continue to plan for approximately 90 new stores this year, comprised of about 75 Ross and 15 dd's. As usual, these numbers do not reflect our plans to close or relocate about 10 to 15 older stores.

Thank you, Barbara. As previously mentioned, our comparable store sales were up 3% for the quarter, primarily driven by an increase in traffic. First quarter operating margin of 12.2% was up 205 basis points from 10.1% in 2023. This improvement was due to lower distribution, incentive and freight costs that were partially offset by the planned merchandise margin decline. Cost of goods sold during the period improved by 140 basis points. Distribution costs levered by 75 basis points while buying improved by 50 basis points. Domestic freight improved by 30 basis points, and merchandise margin declined by 15 basis points as pressure from offering more sharply priced brands was partially offset by lower ocean freight costs. SG&A for the period levered by 65 basis points, mainly due to higher sales. In addition, SG&A benefited from lower incentives versus last year when we significantly outperformed our plans. During the first quarter, we repurchased 1.9 million shares of common stock for an aggregate cost of $262 million under the new 2-year $2.1 billion authorization approved by our Board of Directors in March of this year. We remain on track to buy back a total of $1.05 billion in stock during 2024. Now let's discuss our outlook for the remainder of 2024. Ongoing uncertainty in today's macroeconomic and geopolitical environments, including prolonged inflation, continue to squeeze our low to moderate income customers' purchasing power. As a result, we will remain especially focused on delivering a wide assortment of branded values throughout our stores. For the 13 weeks ending August 3, 2024, comparable sales are forecast to be up 2% to 3%. Second quarter 2024 earnings per share are projected to be $1.43 to $1.49 versus $1.32 for the 13 weeks ended July 23, 2023. Our guidance assumptions for the second quarter of 2024 include the following. Total sales are forecast to increase 5% to 7% versus the prior year. We expect to open 24 locations in the second quarter, including 21 Ross and 3 dd's locations. If same-store sales perform in line with our forecast, operating margin for the second quarter is projected to be in the 11.5% to 11.8% range compared to 11.3% in 2023. Higher sales and lower incentive and distribution costs are expected to be partially offset by a decline in merchandise margin as we build on our efforts to offer more sharply priced brands. We expect net interest income to be approximately $37 million. The tax rate is projected to be about 25%, and diluted shares outstanding are expected to be approximately 332 million. Now turning to the full year. Based on our first quarter results and forward guidance, comparable store sales for the 52 weeks ending February 1, 2025, remain unchanged at up 2% to 3%. We now project earnings per share for the 52 weeks ending February 1, 2025, to be in the range of $5.79 to $5.98 compared to $5.56 for the 53 weeks ended February 3, 2024. This guidance range includes an approximate $0.02 per share favorable impact from the timing of expenses that benefited the first quarter. As a reminder, fiscal 2023 earnings per share included a benefit of approximately $0.20 from the 53rd week.

Thank you, Adam. While overall sales were respectable in the first quarter, there remains uncertainty in the external environment, including prolonged inflation, that continue to pressure discretionary spending from our low to moderate income customers. As a result, it's more important than ever that we remain focused on delivering the best branded values that we can possibly offer. In addition, we'll continue to manage inventory expenses tightly in order to maximize sales and earnings growth over the balance of the year. At this point, we'd like to open up the call and respond to any questions you may have.

Barbara, I wanted to follow up on the efforts to offer more sharply priced products to your customers. Were you pleased with the initial results in the first quarter? Do you think it led to market share gain? And what's the margin implication of your plans to build on this initiative?

Let me begin by discussing our overall progress. In the first quarter, we made strides with our initiatives. While we are still in the early stages, we believe we are in a good position. At this moment, we cannot definitively say if we gained market share from these efforts. Regarding the sharply priced initiatives, Lorraine, could you please repeat that part so I can ensure I address it correctly?

Yes. Lorraine, this is Adam. I'll jump in on that. So higher-quality branded merchandise will typically carry lower margins relative to lower quality, less recognizable brands. So as we move through the year, this will be pressured throughout the year, but will be even more so in the back half of fiscal 2024 as we continue to make further progress on this, as Barbara talked about. We really feel like long term, this is the right thing for us to do to position us to capture market share going forward.

Congratulations on a strong quarter. I'm not sure if Michael is here, but could either Michael or Adam address whether 3% same-store sales growth and a 200 basis points EBIT margin is the new normal? If that's not the case, could you explain the factors affecting gross margin and SG&A for the remainder of the year, especially given the lower expenses compared to plan? I assume we won't see a 200 basis points leverage on 3% moving forward. It would be helpful to understand the context of the 2% to 3% guidance, particularly what worked well in the quarter and what might decrease. Additionally, it seems like dd's have improved more than expected, outperforming Ross just 90 days after you mentioned needing to adjust the assortment and that some stores were underperforming. Could you share your thoughts on dd's performance and the situation with lower-income consumers?

I'll take the first part, Mike. I appreciate your question, but you're correct. The earnings per share exceeded expectations and we benefitted from improved operating margins and reduced distribution costs. We experienced higher productivity in our distribution centers, and our new facility in Houston, which opened a couple of years ago, is now fully operational, contributing to these productivity gains. The hiring and retention conditions in our distribution centers are favorable, and we've made significant investments to enhance productivity there. Additionally, the $0.02 benefit we mentioned related to timing is primarily due to packaway benefits affecting distribution center costs. As anticipated, domestic freight costs were better this quarter, and I expect that trend to continue throughout the year, albeit with some fluctuations. We completed a bidding process that yielded positive results, and currently, fuel prices are slightly advantageous compared to last year.

Michael, there's one other nuance in the first quarter. Because your sales are based on a fiscal basis, your comps are on a restated basis. There's a significant difference between your total sales and your comp sales due to that disconnect, which will correct itself throughout the year. Therefore, we experience higher leverage in the first quarter. However, over the long term, we still anticipate leverage to be around 3% to 4%. Regarding dd's, as mentioned in the commentary, sales trends outperformed Ross. This is partly due to easier comparisons from the previous year, but also because shoppers responded positively to our enhanced value offerings. We're currently in the early stages of adjusting merchandise to further improve those value offerings. While we are encouraged by the initial customer response, it is still very early.

Congrats on another nice quarter. So Barbara, could you speak to the current health of your core consumer today? Or any changes in your view relative to 3 months ago? And then just on cadence, could you speak to traffic versus basket trends as the quarter progressed? And just your confidence in similar performance in the second quarter and the back half of the year.

Matthew, that's a lot to take in, but I'll start with the health of the consumer. I would say it's hard to say on the health of the consumer. There's clearly a lot of uncertainty in the macro economy. The silver lining for our business is the customer is seeking value more than ever, and we're in a position to deliver that. In terms of cadence, as you know, we typically do not get into what the monthly cadence is. I would say that the performance during the quarter was choppy throughout the quarter with weather, the Easter calendar shift and tax refund timing. For us, even though weather was choppy during the quarter, it was relatively neutral for the entire quarter.

And on the comp components, average basket was up slightly. So we had higher AUR driven by a higher mix of brands and is partially offset by lower units per transaction.

The low to moderate income consumer is still facing challenges due to prolonged deflation and the macroeconomic environment. Our focus moving forward is to offer the best possible branded bargains. Consumers desire to buy quality brands but need them at affordable prices. If we can maintain this strategy, it will be crucial for them as they want to continue shopping. However, they need access to products that meet their needs. I don’t anticipate any changes in the pressure on this customer segment, so it’s essential for us to improve our execution. Overall, we are pleased with our progress in brand offerings, but there is still much to do. If we keep executing well, I believe we can continue to serve these customers, despite the challenges they face.

Maybe following up on that last comment. You delivered at the high end of your guidance, but you did comment that you hoped to do better. Have you identified any low-hanging fruit from an execution standpoint in the quarter? Or is the delta versus what you may have hoped for more a function of the external environment being kind of less accommodating for you? And then separately, I was hoping you could speak to the current buying environment, generally, availability across the good, better, best. And as you continue to lean into this value strategy, are the merchants finding any greater ability to offset the margin pressure than maybe you initially thought a few months ago?

Sure. In terms of the sales, our apparel business in Q1 did not perform below the chain. So as we go forward, if we continue to execute at a higher level and continue with our brand strategy, our apparel business, as we go forward, should improve as it historically improves as you get to quarters 2, 3 and 4. So that's the one piece of our business that, in Q1, we were not as happy with and recognize that we have more progress to make, more things to accomplish, and that's a focus for us. So in terms of everything working perfect, I don't believe there's, I would call, low-hanging fruit. I think the whole thing with sales is really going to be about how we execute and how we make the strategic moves we want to make, because the strategies by business of where we are on the brand increases and the penetration is not the same within the company. So some areas have more opportunity as we increase our brands, and some areas, much further along in that strategy because some of those strategies really started at the back end of '23, which is what drove a lot of our '23 business and gave us the courage to go forward and to expand on the strategy. So as we go again, as we go along, we would think that, that would help to improve our sales. In terms of the buying environment, there's absolutely this merchandise availability, as it usually is, and it's pretty broad-based. As usual, there are some businesses that have more availability than others. That's just the natural kind of ebb and flow of the entire scenario. And then just repeat the part about the value. What's the part about value part of your question?

Are the merchants finding greater opportunities to offset the margin pressure than you anticipated a few months ago?

If the merchants are securing better deals, we are passing those savings on to the customer because we believe that providing quality, branded products at competitive prices is crucial for satisfying customers, especially when they are feeling pressured. So that’s our approach at this time.

Curious what you'd attribute to the dd's outperformance to, clearly, a nice surprise today. And then just as a quick follow-up, any thoughts on the home category performance?

Chuck, regarding the dd's performance, part of it was due to easier comparisons to the previous year compared to Ross. However, we believe we've begun to make necessary adjustments, and the customer is responding positively. I want to emphasize that we feel we are just at the beginning of making the required merchandise changes. We'll see how this develops throughout the year.

At a high level, the merchants enhanced their value offerings, including various assortments, broader selections, improved quality, and better products. We believe this is a positive first step. We also see potential for further improvement. If we can meet the needs of low-income customers effectively, that will help us define our strategy. Regarding the home category, it outperformed the overall company performance. There are mixed results within the home segment, with some areas performing better than others. However, it still exceeded expectations, and we see substantial opportunities ahead in the home business given its size and the categories we are involved in. Overall, while some areas are struggling, others are doing well.

Great. Maybe for Barbara, what KPIs are you focused on as you're assessing if some of these value initiatives are working or if they're worth rolling out more across the chain?

The way we're thinking about this is we are actually building the margins the way we see them. We have a merchandise strategy. We've developed a value strategy by type of product, and we then went in and figured out what the margins would be. So at this stage of the game, as you know, we've lowered our margins to be able to get those values on the floor to satisfy the customer and to gain market share. This whole thing is about us gaining market share. So at this point in time, where our strategy is to pass along the values as we get them. And so I wouldn't say it's quite as rigid as, last year, my margin was X and I've got to plan to Y. It's not. It's a strategy we want to execute. And so we've put together, again, all the metrics based off of what we want, the products we want on the floor, the values we want on the floor, and so that we're satisfying the customer because that is the gains to market share. So right now, it's built up bottom up.

It's Tracy Kogan filling in for Paul. I just wanted to clarify if there was anything within cost of goods that was meaningfully favorable to your plan or if it was primarily an SG&A beat. I know you mentioned you expect lower margins on these more recognizable brands, but I'm wondering if you accounted for any benefits from having faster inventory turns or lower markdowns because these are brands that customers want.

Within the cost of goods sold, Tracy, freight is included in our cost of goods sold, and we did see favorability.

Yes, and the DC cost.

We have built our offerings around recognizable brands, which tend to sell quickly. However, we are able to move all our products swiftly. In terms of markdowns, I do not see quick turnover as a major factor for us. Our markdowns will be reasonable considering the value and retailer associations of the brands. We approached this from a bottom-up perspective and did not set specific expectations for how quickly items would sell based on supply weeks. We are in a learning process, and as we proceed, we are fine-tuning our strategy. We do expect our turnover rates to improve, but we did not plan with a particular turnover expectation in mind. Overall, we believe we can manage everything efficiently, and our expectations will be aligned with what we think customers will accept.

Great, and nice quarter. Barbara, my question is on the packaway. The 41%, I believe, was this quarter. Typically, if I'm correct, that's typically short stay, I think. Can you comment on if you were being impacted by weather events as with TJX than most frontline retailers also would be? Are you seeing that short stay opportunity? And have you taken advantage of it to deploy in the second quarter, perhaps?

Adrienne, regarding the packaway, it usually remains for about four months on average. However, it can certainly be utilized for a shorter duration if necessary.

In response to your question about potential closeout opportunities due to adverse weather conditions across the country and the movement of goods by vendors, I believe that some vendors are beginning to shift their inventory. However, others are holding onto their goods based on their financial circumstances and the situation you're describing. The weather has indeed been challenging, and at this moment, vendors may not feel the urgency to move their products. If we were discussing this around mid-June, my answer might differ. The answer varies depending on the vendor, their specific needs, and their cash flow status. While there have been some closeouts, the substantial influx of inventory that would motivate us to make quick purchases has not yet happened. Currently, it seems that vendors are not overly concerned about their products.

Great quarter. Can you provide more insight on the geographic differences and if there has been significant variation in performance within both Ross and dd's store base?

Sure, Bob. I would only talk on a consolidated basis. But as we said in the commentary, the geographic performance was strongest in California and the Pacific Northwest. Both of those are areas that were impacted by poor weather last year, so easier compare perhaps. For our other largest markets, Texas was above the chain while Florida was just slightly below.

Just so recognizing the goal for the sharper prices, what is the implied average unit retail embedded within the comp guides that you've given? And then just higher level, as you think about the challenges of the environment, but also perhaps the potential trade down into your business as you think about the market share, I guess how do you assess prioritizing the assortment of sharply priced brands versus maybe some better brands that are a little bit higher priced but still great value to bring people in?

On AUR, I'd say we don't plan or focus on driving a specific price point. While it was up in the first quarter, our focus is on delivering the most compelling value as possible, which, as we said, we believe will drive sales and market share gains.

In terms of the sharper prices, I want to clarify that the term sharper prices mainly refers to goods. I should probably use the phrase stronger values on the floor instead. This concept applies across various tiers, not just looking for an opening price point strategy; it's more about a value strategy. For instance, if we offer four different types of products, we might have enhanced one of those three categories so that customers receive an even better deal or value. That's how we're approaching the strategy. I realize using the word price might be confusing for some, but does that answer your question?

Yes, that makes a lot of sense. Good clarification. Do you see that as an opportunity for customers to trade down to your products from those that are not in your core offerings?

I think it's challenging for us to measure. However, the more brands we acquire and the wider the assortment we offer, the more customers we'll attract. Our goal is to increase market share, which involves appealing to different customers. Therefore, if we expand our branded products, provide exceptional value, and broaden our selection, that combination should help us capture more market share.

It's a good question. I think right now, as you know, we slowed down growth specifically in the new markets. I think we'll have to see sustained trends before we reaccelerate growth in those newer markets. But if we see it, then we would do so.

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