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What's Hurting Ross Stores (ROST) Stock Despite a Strong Q3?

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Ross Stores Inc. (ROST - Free Report) stock is witnessing a trough since it reported third-quarter fiscal 2018 results on Nov 20. Though the company delivered its 10th consecutive earnings beat in the fiscal third quarter, investor sentiments seem to be hurt due to headwinds related to higher freight costs and wage investments. These headwinds are weighing on the company’s margins for a while. Moreover, its top line lagged estimates in the fiscal third quarter.

Shares of this Zacks Rank #3 (Hold) company rolled down as much as 10.5% since reporting earnings on Nov 20. This marked an underperformance compared with the industry’s decline of 6.2%.

 



Nonetheless, the company’s commitment to better price management, merchandise initiatives, cost containment and store expansions should cushion the stock in the long term. Additionally, Ross Stores’ raised earnings outlook for the fourth quarter and fiscal 2018 indicates that the stock might pick momentum as the quarter proceeds.

Factors Weighing on the Stock

Ross Stores continues to grapple with higher freight and wage-related costs, which are hurting margins for a while now. Though the company reported a strong fiscal third quarter, its operating margin of 12.4% reflected a decline of about 90 basis points (bps) from 13.3% in the prior-year quarter due to the aforementioned headwinds. Notably, higher freight costs have been a headwind for the company for over a year now. The increase mainly stemmed from significant rise in market rates due to a very tight capacity, owing to driver shortages, impacts of increased regulation and the stronger economy.

Further, higher freight costs, and buying and distribution expenses in the fiscal third quarter contributed to 7.5% or 60 bps increase in the cost of goods sold. Additionally, SG&A expenses as a percentage of sales increased 30 bps owing to higher wage-related investments.

Ross Stores continues to expect headwinds related to higher freight costs and wage investments to persist throughout fiscal 2018, which is well reflected in its guidance. The company projects operating margin of 12.6-12.8% in the fiscal fourth quarter, reflecting a decline from 14.6% in the year-ago quarter.

Additionally, Ross Stores expects to witness the toughest sales comparisons from fiscal 2017 as the holiday season starts. It expects the retail environment to be extremely competitive during this time.

Silver Lining

Robust Outlook

Despite the aforementioned headwinds, Ross Stores looks poised for growth as reflected in its robust view for the fourth quarter and fiscal 2018. The company continues to expect a strong holiday season, with comparable store sales (comps) anticipated to grow 1-2%. It also raised the earnings per share guidance for the fourth quarter and fiscal 2018.

The company now expects earnings per share of about $1.09 to $1.14 for the fiscal fourth quarter versus $1.02-$1.07 mentioned earlier. The revised guidance includes one-time non-cash gain of 7 cents from the favorable resolution of a tax issue. It also compares with $1.19 per share earned in the year-ago quarter, which includes benefits of 14 cents and 10 cents, respectively, from one-time revaluation of deferred taxes and the 53rd week.

For fiscal 2018, the company now projects earnings per share of $4.15-$4.20, marking an increase from $4.01-$4.10 projected earlier.

Long-Term Potential Intact

Ross Stores’ off-price model provides strong value proposition and micro-merchandising that drive product allocation and margins. This helped it deliver solid top- and bottom-line trends. Additionally, the company’s merchandising efforts and store expansion plans have been working well.

Ross Stores has consistently been on track with its store expansion plans. This is clear from the opening of 40 stores in third-quarter fiscal 2018 (including 30 Ross and 10 dd’s DISCOUNTS stores), marking the completion of its targeted 100 store openings for fiscal 2018 (comprising 75 Ross and 25 dd’s DISCOUNTS stores).

The company’s focus on store expansion is further highlighted by a recent research, which suggests that it has the potential to increase penetration in the existing as well as new markets. Consequently, it raised the long-term projected store growth target to 3,000 from 2,500 mentioned earlier. This will include the opening of nearly 2,400 Ross Dress for Less stores (up from 2,000 stated earlier) and 600 dd’s DISCOUNTS stores (up from the prior assessment of 500).

Looking for More? Check These Lucrative Picks

Some better-ranked stocks in the same industry are Burlington Stores Inc. (BURL - Free Report) , Dollar General Corp. (DG - Free Report) and Target Corp. (TGT - Free Report) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Burlington Stores has surged 46.2% in the past year. It has average long-term earnings per share growth rate of 20.8%.

Dollar General has returned 21.9% in the past year. It has average long-term earnings per share growth rate of 13.6%.

Target stock has escalated 23.9% in the past year. Moreover, the company has average long-term earnings per share growth rate of 6.7%.

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