Ross Stores Inc (ROST) — Q2 2024 Earnings Call Transcript

Good afternoon. Joining me on our call today are Michael Hartshorn, Group's 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 second quarter 2024 results, followed by our outlook for the second half and full fiscal year. Afterwards, we'll be happy to respond to any questions you may have. As noted in today's press release, second quarter sales and earnings were above our expectations as our stronger value offerings resonated with our customers. Operating margin improved versus last year, increasing 115 basis points to 12.5%. Total sales for the period grew 7% to $5.3 billion, up from $4.9 billion last year with comparable store sales up 4%. Earnings per share for the 13 weeks ended August 3, 2024 were $1.59 on net income of $527 million. These results are up from $1.32 per share on net earnings of $446 million in last year's second quarter. For the first six months, earnings per share were $3.05 on net income of $1 billion. These results compare to earnings per share of $2.41 on net earnings of $818 million for the first half of 2023. Sales for the 2024 year-to-date period grew to $10.1 billion, up from $9.4 billion in the prior year. Comparable sales for the first half of 2024 were up 3%. Cosmetics and Children's were the strongest merchandise areas during the quarter, while geographic performance was broad-based. Like Ross, dd's DISCOUNTS performance also improved as shoppers responded favorably to the stronger values and fashions offered in stores. In addition, dd's faced easier comparisons versus last year, benefiting their recent performance. While we are encouraged by the improved trends, we continue to adjust assortments in the newer markets to address this more diverse customer base. At quarter end, total consolidated inventories were up 8% versus last year, while average store inventories were up 3% due to the 53rd week calendar shift. Packaway merchandise for 39% of total inventories at quarter end, up slightly from 38% last year. Turning to store growth. We opened 21 new Ross and three dd's DISCOUNT locations in the second quarter. We remain on track to open a total of approximately 90 new locations 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. Now, Adam will provide further details on our second quarter results and additional color on our updated outlook for the remainder of fiscal 2024.

Thank you, Barbara. As previously mentioned, our comparable store sales were up 4% for the quarter, driven by a combination of higher traffic and basket size. Second quarter operating margin of 12.5% was up 115 basis points over 11.3% last year. Our improved profitability benefited from higher sales and lower distribution and incentive costs that were partially offset as planned by lower merchandise margins. Cost of goods sold during the period improved by 60 basis points. Distribution and buying costs delivered by 70 and 55 basis points, respectively, while domestic freight costs declined by 15 basis points. As expected, merchandise margin decreased by 80 basis points. SG&A for the period improved by 55 basis points, mainly due to higher sales and lower incentive costs. During the second quarter, we repurchased 1.8 million shares of common stock for an aggregate cost of $262 million. As a result, we remain on track to buy back a total of $1.05 billion in stock for the year. Now let's discuss our outlook for the remainder of 2024. As Barbara noted in today's press release, our low to moderate income customers continue to face high costs on necessities, pressuring their discretionary spending. Looking ahead, our prior year sales comparisons also become more challenging during the second half of the year amidst an external environment that is highly uncertain. As a result, we continue to maintain a cautious approach in forecasting our sales. For both the third and fourth quarters, we are planning comparable sales growth of 2% to 3% on top of 5% and 7% gains, respectively, in 2023. If sales perform in line with this guidance, third quarter earnings per share are expected to be in the range of $1.35 to $1.41 versus $1.33 last year and $1.60 to $1.67 for the fourth quarter compared to $1.82 in 2023. This updated earnings guidance now reflects additional efficiencies we expect to achieve in the second half of 2024. If the second half performs in line with these projections, earnings per share for the full year are now forecasted to be in the range of $6 to $6.13, up from $5.56 in fiscal 2023. As a reminder, both the 2023 fourth quarter and full year results included an approximate $0.20 per share benefit from the 53rd week. Now, let's turn to our guidance assumptions for the third quarter of 2024. Total sales are forecast to increase 3% to 5% versus the prior year. We expect to open 47 stores during the quarter, including 43 Ross and 4 dd's locations. Operating margin for the 2024 third quarter is planned to be in the 10.9% to 11.2% range, compared to 11.2% in 2023. This outlook reflects lower incentive, freight and distribution costs that are offset by lower merchandise margins as we build on our efforts to offer more sharply priced branded bargains. Net interest income is estimated to be approximately $39 million. The tax rate is projected to be 24% to 25%, and diluted shares outstanding are expected to be approximately $331 million. Now, I will turn the call over to Barbara for closing comments.

Thank you, Adam. While second quarter sales and earnings were above our expectations, we remain keenly aware of the uncertain external environment. In addition, we recognize that delivering the great values that our off-price customers have come to expect from us is more important than ever, especially given the continued pressures they face from the highest cost on necessities. Thus, we will stay laser-focused on maximizing our prospects for market share gains by providing shoppers with the most quality branded bargains in the marketplace. At this point, we'd like to open up the call and respond to any questions you may have.

Great. Thanks and congrats on a really nice quarter. So Barbara, could you elaborate on the progression of business trends that you saw during the quarter? And just progress with your initiatives to amplify value, as well as brands into the back half of the year? And then for Adam, on gross margin, could you just maybe speak to the mark on opportunity based on current availability of goods or how best to think about gross margin drivers in the back half?

Matt, I'll start with comp performance during the quarter. Cadence-wise for us, comps were strongest mid-quarter, both on a single year and a multiyear stack basis.

And then in terms of progress on the value strategy, the stronger value offering is definitely resonating with our customers. So in the fall season, we're going to continue to build on improving that value offering that we have out there now. And again, I just said it in my opening, the customer is really dealing with high costs on necessities. And I think the way for us to gain market share is really to continue down this value path.

And Matt, this is Adam. I understand your question about the remainder of the year and specifically regarding mark on. Let me explain some of the details. We mentioned a 70 basis point leverage in direct costs during the quarter. We are observing increased productivity in our distribution centers due to our investments in automation. The hiring and retention environment remains strong. Our new distribution center in Houston is contributing positively. Buying costs were favorable; however, lower incentives were the main factor affecting that. As anticipated, domestic freight slightly benefited us, while ocean freight remained neutral in relation to mark on specifically. The challenge we face is with our merchandise margin. We have discussed our brand strategy, which is gradually ramping up as we progress through the year, and the merchandise margin decreased by 80 basis points. We expect this pressure to increase as we enter the second half of the year.

Great color. Congrats again.

Thanks, very much. Great quarter. I was wondering if you could maybe touch on the cadence, talk about anything on the back-to-school results thus far. And also within categories, if you could speak to the home and also where you are on the apparel trends in the quarter? Thank you.

Sure, it's Michael Hartshorn. We won't discuss inter-quarter trends as we head into Q3. However, I can share that our strongest comparisons were in the middle of the quarter. In terms of merchandise categories, Cosmetics and Children's items performed the best, while Home was consistent with the overall chain performance. Shoes lagged a bit due to challenging comparisons from last year, and Apparel was generally in line with the average across the chain.

Good afternoon. Thank you for taking my question. So just thinking about the updated guide here, you beat the high end of your EPS guide by $0.10 in the quarter. I think you're raising the high end for the full year to $0.15. Second half comp still in that 2% to 3% range. So maybe just talk us through any key changes to the operating outlook for the back half of the year, key margin drivers for the back half versus what you were expecting 90 days ago? I think you mentioned some additional efficiencies, maybe expand on that and just anything else you can call out? Thank you.

Sure. Nothing has really changed for the second half of the year compared to our original plan. The main change is that we have reflected the positive results from the second quarter throughout the year. Additionally, due to our expense and cost-saving initiatives, we have provided an updated perspective on the efficiencies in our business. We are constantly seeking ways to enhance productivity, especially in light of the anticipated pressure on merchandise margins from our branded strategy. Overall, we began the year with a certain projection, and we are currently slightly ahead of that, which has been incorporated into our guidance for the second half.

Thank you.

Thanks, guys. I think you said basket was up, curious if you could maybe talk about AUR versus UPT? Also curious if you could share where you are right now on a dollar basis? What is the current AUR in the business, current basket size? And then second, just curious, I know you said your customer is under pressure, but I'm wondering if you noticed any change in your customer behavior in the second quarter versus the first quarter or how you were thinking your customer might behave when you gave guidance originally? Thanks.

Sure, Paul. First, on the AUR for the quarter, the comp was driven by a combination of higher traffic and a higher basket. The average basket was slightly up as average unit retails were partially offset by fewer items per transaction. On the AUR, we're not focused on driving specific price points, but rather we're focused on offering a good, better, best product assortment at a great value. We don't give specifics on the actual AUR or the basket. In terms of health of the consumer, I would say, based on our performance since it improved in the second quarter, what I would say, though, for us, it's obviously – we saw an improvement. But judging from industry reports, both in the first quarter and now year-to-date, the customer is clearly seeking value now, especially with, what I’d say, stubbornly persistent inflation on necessities and also an uncertain macro economy. As a result, now more than ever, we believe price value is critical for her when determining where to shop.

And did I hear right thing that AUR was up a little bit, UPT is down?

Yes, correct.

But can you just maybe tie that together with the focus on value, providing the customer more value? Is there a mix impact to that AUR? Just curious what would explain it being higher as you offer more value?

Sure, Paul. It’s about – it aligns with our branded strategy. Again, we’re focused on providing more brands at a great value, and that’s led to the slight increase in AUR.

Got it. Makes sense. Thank you.

Thank you for taking our question and congratulations on a great quarter. Could you elaborate on the merchandise margin a bit more? I initially thought that the pure product margin would face the most year-over-year pressure in the second quarter, since you started implementing some of the merchandise strategy in the latter half of last year. I understand that promotions are included in that figure, so could you clarify that for us? Is the product margin pressure better or worse as we move into the second half of the year? Additionally, I know you typically mention a point of upside on same-store sales, contributing around 10 or 15 basis points of leverage. It seems you achieved about 70 basis points with the one-point beat at the top end. Could you break down the factors that contributed to this favorability and share any thoughts on whether this trend will continue in the second half, or if there might be better flow-through opportunities?

Just to start with the flow-through. The upside was obviously driven by sales. And to your point, that's about 10 to 15 basis points for every point in sale. But we also saw a better improvement on some of the expense initiatives and cost initiatives we have in the business. And so based on that, that's the upside that we forecasted in the back half of the year.

Yes, Michael, this is Adam. I'll jump in on the margin side of the question, right? We did start our efforts at the end of last year, but really the step-up was this year, right? And that's why you saw gradual pressure in Q1. We were about 15 bps worse than the prior year, but some of that, we still had some residual ocean freight benefit that was helping that number in Q1. We reported the 80 basis points in Q2. And as I mentioned, as we continue to increase that penetration of brands and going after more brands, we'll see additional pressure in the back half.

Thank you.

Great. Thanks all for taking the question. Congrats on a nice quarter. Just on expense and cost savings that you say you're finding and you expect more in the back half. Can you just give us a little bit more color around some examples of what those are? And are they more COGS benefits or SG&A benefits or both? Thanks a lot.

Sure. I'll provide a few examples. We are utilizing automation in our distribution centers and continue to enhance operations across the business, both in distribution centers and retail locations. For instance, we have introduced automated vehicles for inventory movement, robots for carton assembly, and automated sorting systems for inventory meant for stores. We have various initiatives to support our associates. We tested self-checkout systems in selected locations, rolled out new handheld devices for inventory checks and markdown management, and are currently implementing flexible scheduling to boost productivity in the stores.

And Alex, building on that a bit, we've found efficiencies in multiple parts of the P&L. I'd probably speak to domestic freight as being one primary example, where given what we're seeing from our rate structure and our contracted rates, a little bit of help from fuel costs. We thought it made sense to flow that through specifically in the back half.

Thank you. Good afternoon. Can you quantify the merchandise margin decline that you're expecting in the second half? And are there additional operating efficiencies available to offset any further merch margin pressure into next year?

Lorraine, this is Adam. We're not specifying the exact impact on the merchandise margin, but we do anticipate it to be greater than the 80 basis points we reported in Q2. I mentioned domestic freight as a primary offset we will have in the second half, along with improvements in distribution costs that Michael discussed. Given our strong performance from a profitability perspective in the first half, we expect to see some positive developments in incentive costs as we approach the second half. These areas are likely to be the main factors that will help mitigate the merchandise margin impact.

And Lorraine, it's at this point, too early to talk about 2025. We're just starting to go through our budget process for next year.

Thank you.

Hi. Good afternoon everyone. As you think about the ladies business, the home business, any updates on their performance and your focus, Barbara, on brands in each of those businesses? And in mind of this focus on value, how are you thinking about pricing as we move forward into the back half of the year? Thank you.

Certainly. In terms of the ladies business, our primary focus is on adjusting our product assortments to include more branded items and enhance their value, as the ladies segment is essential to our overall operations. We're continuously learning and evolving, adding new vendors and experimenting with value propositions. This approach will remain dynamic as we make necessary adjustments. Our emphasis is on providing value rather than just focusing on price, especially when comparing against competitors in various retail segments. For the home business, which is less branded compared to ladies, men's, or children's categories, we are zeroing in on specific areas where strong brands exist in the market. Our aim is to ensure that when customers compare our offerings to well-known brands, they recognize the significant value we provide. This strategy is integral to capturing market share, and we're discovering that it effectively drives sales across different businesses at varying stages of implementation. We're not specifically planning for average unit retail pricing; rather, our focus remains on delivering value. While we will maintain a diverse assortment that includes good, better, and best brands to cater to all customers, we are committed to preserving the variety of price points in our stores. This variety is crucial to the shopping experience. As we observe competitor sales and promotional strategies, we will continue to conduct competitive analysis to track pricing trends. Ultimately, our goal is to ensure that customers feel they receive exceptional deals consistently. Each business is at a different point in this journey, but this is our current approach.

Thank you.

Good afternoon and thank you for taking our question. Barbara, can you talk to the level and quality of inventory available in the marketplace today? Are you seeing any additional opportunities for new vendor partnerships? And are you seeing inventory opportunities come in at a better mark on rate for margins? Thank you.

So in terms of just inventory availability, the ability remains favorable. It's pretty broad-based, as I would normally say some businesses having more than others, but it's still out there. In terms of quality itself. One is just availability. One is the quality of availability. Again, it's kind of in all the brands here of products that there are. Brooke, what was the second question you said?

Whether or not you're getting new vendors?

Sure. We are indeed expanding our vendor base, which adds value to our operations. In light of the current challenges in certain market segments, vendors are eager to build relationships and increase business. Particularly in the cost price sector, we are seeing more activity. Overall, we believe we are well-positioned to add new vendors and strengthen these relationships.

Hi. Good afternoon. I have a couple of quick questions. Can you discuss how shrink is performing within your business? Also, how are the California stores doing compared to the rest of the chain? Lastly, could you provide some insight into the labor and wage rates, as well as any wage pressures you are experiencing throughout your chain? Thanks.

Sure. I'll address all of these points. Starting with shrink, it remains a challenging retail theft environment, and we are not immune to it. We are investing in loss prevention initiatives to manage shrink effectively, but we are also concentrating on executing the measures we currently have in place. We will assess shrink in the third quarter, and our guidance anticipates some decline compared to last year. Regarding geographic comparisons, as mentioned earlier, they were quite broad-based. In our largest market, California, performance exceeded the chain average, while Florida matched the chain's performance, and Texas fell slightly below average, partly due to the impact of Hurricane Beryl during the quarter. On the subject of wages, overall wages in our stores and distribution centers are fairly stable. Most wage increases this year stem from mandated wage hikes in specific markets and states. Therefore, our approach to staffing will remain market-focused, making wage adjustments as necessary. As Adam mentioned earlier, improvements in productivity within our distribution centers are partly attributed to a stable labor market in that sector, resulting in lower turnover and increased productivity from our experienced staff.

Okay. Thank you.

Thank you very much. Congratulations, Barbara. I was curious if you could share insights on the current behavioral patterns of your target consumers. We've been hearing that shopping habits are returning to pre-pandemic levels, with busy days contrasted by quieter ones and consumers purchasing closer to their immediate needs. Could you elaborate on that? Additionally, as the retail environment becomes more promotional, are you planning to maintain your historical pricing strategy, or are you considering sharpening it further to capture additional market share? Thank you.

On the traffic patterns, we haven't seen a significant change. Certainly, the events are more important. But as far as traffic during the quarter or during the week or during the weekends or towards events. We haven't seen a significant shift.

As the retail environment becomes more promotional, we don't have a standard historical spread. Merchants are closely monitoring the situation and assessing outcomes. This requires anticipating retailer actions, particularly in uncertain areas. We lack a historical benchmark, so we plan to price as competitively as possible. We will make informed decisions while recognizing that our value strategy is the right approach for us. We'll proceed with our established processes to set what we believe to be a strong value.

I have a clarifying question regarding the AUR and the branded products. How much more branded product do you have this year compared to last year? The AUR for the brands is higher, but are the merchandise margins relatively flat, or are they lower because of the branded products? I'm curious about how the merchandise margin aligns with the AUR trend. Thank you.

Adrienne, this is Adam. I'll jump in. We wouldn't speak to kind of the mix of our business, how much is branded and non-branded. But the merchandise margin pressure that I spoke to is all related to the brand strategy and that step-up in penetration.

Okay. Fantastic. Thank you. Very helpful. Best of luck.

Hi, everyone. Just a quick question, I guess, for me on the branded strategy. Clearly, it's successful. The comps you guys have been up late last year and early this year are pretty robust. I guess just at a high level, I know you're not going to give us your plans for 2025 and beyond. But is this a strategy that has multiyear duration? Is this more of a strategy that you kind of unlock it, you just let it ride as it is? I'm just kind of curious is there a step functions to it as we kind of move forward in terms of mix without quantifying that? So just at a high level, I would be curious.

I think we're still learning on the brand strategy. What the right mix, what the right penetrations are by business. So I don't think we could quite answer that today. Obviously, our goal is to drive top line sales. But we got a lot of learning so far. We had a lot of learnings in spring. I'm sure we'll have more learnings for fall. And we're going to build off the success of those learnings based on what the customer is telling us.

Hi, everyone, congratulations on the quarter. I wanted to ask about the kids business for a moment. The assortments look really good in stores, particularly some of the assortments that have been challenging. Are the recent trends reflecting back-to-school? If not, could you share any insights about what back-to-school might look like in August? I also know you mentioned that customers have not changed their purchasing behavior or are not buying closer to their needs. Are you noticing any delays in their purchases for major seasonal items like back-to-school or holidays such as July 4th or Halloween? Thank you.

Thank you for the compliment on our Kids line. At this moment, we won't discuss back-to-school since we are still in the midst of it. There are still some items to consider as we proceed. Regarding purchasing delays, there has been a slight shift in calendar timing. Currently, I'm purchasing some items now, like shorts, as I prepare for back-to-school. We've observed this trend for a couple of years. It's important to find the right mix to make a conversion. Using the example of denim shorts and long denim, both are performing well, likely due to the right balance in our inventory. Kids are still returning to school, and shorts need that final push, but the key is managing inventory effectively.

It's too early to assess factors like July 4th purchases or any changes regarding Halloween shopping. In the past, we often saw customers buying well in advance of holidays. Recently, however, there's been a noticeable trend of customers making their purchases in a rush the week leading up to these events.

You're suggesting that Halloween items were sold much earlier three years ago compared to today. I believe it depends on the events this morning. Some holidays tend to sell early and continue selling, while others might be less prioritized and are purchased closer to the date. However, that can vary from year to year. Additionally, it has a significant connection to the variety of products available, and their overall appeal.

Yes. That makes sense. Best of luck with fall, guys.

Thank you.

Thank you.

Thanks for taking my question. Congrats on a great quarter. So Adam, when you think about the long-term margin potential of the business, there's been some tremendous flow-through on the three comp in Q1 and now the four comp in Q2. To the bottom line, how do you think about the long-term operating margin structure of the business? You've been as high as 14% in the past. Obviously, there's been a lot of wage inflation and supply chain inflation. I'm just wondering what's the ceiling for this business from a long-term margin perspective?

John, I would say nothing has changed. We still believe that an additional point of comparable sales leads to a margin expansion of 10 to 15 basis points, and that remains consistent. In the long term, achieving sustained significant sales gains will be our main driver. Another factor to consider is how inflation affects us, particularly regarding fuel costs and wages, and whether these will remain relatively stable. Those are the most significant long-term considerations.

Got it. Thank you.

Thank you and congrats on the good quarter. So Barbara, last quarter, you talked about apparel having underperformed for a while. Now it's in line with chain. As you go into Q3, are you happy now with where you are on the brand's assortment? Or do you see continued progress even in season between Q3 and Q4 as you get through the back half of the year? And then I have a quick follow-up, Adam or Michael, on the incentive comp. You've now beat plan for two quarters. Based on your current raised guidance for the back half, do you expect to still see incentive accruals benefit in the back half? Or do you see that benefit gradually moderating based on the performance so far? Thanks.

In terms of apparel underperformance and now apparel being in line with the chain, apparel is in line with the chain. Ladies, however, is still below the chain average. So in all the areas, we're expecting to see more progress in apparel as the year goes on. So we're building upon the learnings, building upon the things that the customer is voting for. And so I think that's going to be for the next six months for all it takes us to really truly understand it. But in grand total, it was in line. But as you know, Children's outperformed. So Ladies underperformed.

And Aneesha, on the incentive piece, with the guidance that we're providing, we would still expect to see some incentive benefits. So again, it's we're going up year in 2023 where we significantly exceeded our financial plans, while we feel good about how we're tracking. We're up against a really outsized year.

Okay. Thank you.

Great. Thanks. Barbara, I think you mentioned in response to a prior question that you're expanding the number of vendors that you have. Is there any way to put into historical context what the amount of new vendors you're adding might look like versus history? And if there's any incremental buying expense or people that you had to bring on to accommodate that?

I can't provide a specific number. The reality is that with vendors, some go out of business while others enter or expand, making it difficult for me to quantify this for you.

Okay. Understood. And then just as it relates to shoes, is there any way you could talk about within the category, what you saw in lifestyle or athletic shoes versus brown shoes perhaps?

Sure. First of all, shoes underperformed the chain, but was up against a very, very large comp. I think it was a little mixed on the way into the season. Athletic overall has been pretty good. As has active meet certainly some brands better than others. But overall, athletic and active has been good. It's been a little bit more mixed on brown shoes depending upon for woman’s, ladies or kids. But we did see the run-up in flat handles, we did see block yields. We did see the sandal things take off. And we're a little bit more strategic in our transition as we're going into fall because last year we slowed foots early. And they did not perform early. And this year, we made a shift in timing.

Great. Thank you. My question is about international. Some of your competitors have talked about maybe doing deals or they have announced deals with off-price retailers in international markets. Have you explored that? I mean what are your thoughts about Ross expanding into international markets?

Good question. I wouldn't comment on the deals. However, we currently operate 2,100 stores and believe we can expand to 2,900 Ross stores and 700 dd's, indicating significant growth potential in the U.S. Our focus is on profitably increasing our store base over the coming years, and that is where we are directing our efforts.

Okay. Thank you so much.

Thanks for taking my question. You called out additional efficiencies benefiting your EPS guide in the back half and then gave some examples of those. How long is the tail there? Meaning, is this part of a longer-term program that will benefit earnings and margins into next year? Or should we just see the positive benefit of lapping in the first half and then it flattens out?

I would respond to that in a few ways. Firstly, there are several initiatives, each with its own timing. Some will extend into next year, some will support us in the coming year, and others will conclude this year. Additionally, we are looking into the next generation of efficiencies for next year. Long term, we believe we can continue to gradually increase our EBIT margin at a 3% to 4% growth rate, and that perspective remains unchanged.

Got it. Thank you.

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