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Can Ross Stores (ROST) Regain Momentum Amid Supply Concerns?

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Ross Stores Inc. (ROST - Free Report) has shown resilience over the past year despite the tough market conditions. The company has been gaining from robust customer demand, accelerated vaccination rates, government stimulus payments and easing of COVID-19 restrictions in recent months. This led to the better-than-expected top and bottom-line performances in second-quarter fiscal 2021.

However, the recently surfaced elevated freight and distribution expenses, supply-chain constraints, and the expectations of continued COVID-related expenses have been hurting investors’ sentiment on the stock.

Shares of Ross Stores have declined 4.8% in the past three months against the industry’s growth of 6%. However, the Zacks Rank #3 (Hold) stock has risen 25.7% in the past year. Although the company’s robust surprise trend in the past two quarters raises optimism, the continued risk of COVID-related headwinds due to the spread of variants and the impacts of the industry-wide supply-chain congestion have been concerning.


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Factors Favoring the Stock

Ross Stores has been displaying strength in terms of earnings and sales, which improved 22% and 20.7%, respectively, in second-quarter fiscal 2021 from second-quarter of fiscal 2019. Sales benefited from broad-based growth across all merchandise categories and regions. Earnings benefited from the cost of goods sold (COGS) leverage, rebound in the operating margin, stringent inventory management and reduced Packaway. Strong sales, improved merchandise margins and occupancy, and lower buying costs aided Ross Stores’ operating margin in the fiscal second quarter.

The company has been benefiting from its inventory management efforts despite delays in receipts due to the ongoing industry-wide supply-chain congestion. At the end of the fiscal second quarter, consolidated inventories declined 5% from the comparable fiscal 2019 levels. Packaway levels were at 30% compared with 43% at the end of second-quarter fiscal 2019. The lower packaway levels resulted from the use of a substantial amount of packaway ahead of planned sales.

Ross Stores has been consistent with the execution of its store expansion plans over the years. The company’s store expansion efforts are focused on continually increasing penetration in the existing as well as new markets. In fiscal 2021, the company now anticipates opening 65 locations, including 45 Ross Dress for Less and 20 dd’s DISCOUNTS. The company intends to return to its normal annual store opening target of 100 stores in fiscal 2022. Earlier, it projected to expand the Ross chain of stores to 2,400 locations alongside operating 600 dd’s DISCOUNTS stores over the long term.

Hurdles on the Path

Ross Stores like others in the industry has been witnessing the effects of the worsening industry-wide supply-chain congestion, which has led to higher freight and distribution expenses. This partly impacted the company’s COGS rate in the fiscal second quarter. In second-quarter fiscal 2021, the company’s COGS rose 19.9% from second-quarter fiscal 2019. COGS was partly affected by higher distribution costs and worsening industry-wide supply-chain congestion, leading to higher freight expenses.

Distribution expenses rose 40 bps on wage increases and freight cost accelerated 85 bps. The company expects a significant rise in freight costs and distribution expenses in the near term, which is reflected in its third-quarter fiscal 2021 guidance.

The company has been witnessing costs related to COVID-19 for some time now. In the fiscal second quarter, it incurred net COVID-related costs of roughly 45 bps. The majority of the expenses impacted SG&A expenses. Impacts on the SG&A expense rate mainly included elevated operating expenses associated with the pandemic and higher incentives, which offset the strong sales performance. The company anticipates the wage increases to continue to hurt margins in the fiscal third quarter.

Ross Stores provided a cautious view for the fiscal third quarter as there remains greater uncertainty regarding the sustainability of the external factors, aiding its results and the risk of COVID-related headwinds due to the spread of variants and supply-chain congestion. It notes that the recent spread of the delta variant may result in some consumers refraining from visiting stores. It also expects the benefits of the pandemic-related stimulus packages witnessed in the first half to fade relatively in the second half. The company’s guidance reflects comparisons with the respective fiscal 2019 period.

Ross Stores expect earnings per share of 61-69 cents for third-quarter fiscal 2021, whereas it reported $1.03 in third-quarter fiscal 2019. Sales are anticipated to grow 9-12%, with comps expected to increase 5-7% from the third-quarter fiscal 2019. It expects an operating margin of 7.3-7.9%. The guidance takes into account the expectations of a significant rise in freight costs and distribution expenses as well as the impacts of COVID-related costs on EBIT margins. It anticipates COVID-related costs to affect EBIT margins by 45 bps in third-quarter fiscal 2021.

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Costco Wholesale Corporation (COST - Free Report) has a long-term earnings growth rate of 9.3%. It currently has a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The TJX Companies, Inc. (TJX - Free Report) , with a Zacks Rank #2 at present, has a long-term earnings growth rate of 10.5%.

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