Ross Stores, Inc. (ROST) Q3 2023 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Ross Stores Third Quarter 2023 Earnings Release Conference Call. The call will begin with prepared comments by management followed by a question-and-answer session. [Operator Instructions] Before we get started, on behalf of Ross Stores, I would like to note that the comments made on this call will contain forward-looking statements regarding expectations about future growth and financial results, including sales and earnings forecasts, new store openings and other matters that are based on the company's current forecast of aspects of its future business. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from historical performance or current expectations. Risk factors are included in today's press release and the company's fiscal 2022 Form 10-K and fiscal 2023 Form 10-Qs and 8-Ks on file with the SEC. And now I'd like to turn the call over to Barbara Rentler, Chief Executive Officer.

Good afternoon. Joining me on our call today are Michael Hartshorn, Group President and 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 third quarter performance followed by an update on our outlook for the fourth quarter and fiscal year. Afterwards, we'll be happy to respond to any questions you may have. As noted in today's press release, we are pleased that both sales and earnings outperformed our expectations for the quarter as customers responded favorably to the terrific values we offer throughout our stores. Operating margin for the period was 11.2%, up from 9.8% last year. Leverage from the same-store sales gain and lower freight costs were partially offset by higher incentives and store wages. Earnings per share for the 13 weeks ended October 28, 2023, were $1.33 compared to earnings per share of $1 last year. Net income for the period rose to $447 million versus $342 million in the prior year period. Total sales for the quarter were $4.9 billion, up from $4.6 billion last year, with the comparable store sales gain of 5%. For the first 9 months, earnings per share were $3.74 on net earnings of $1.3 billion compared to $3.08 per share on net income of $1.1 billion for the same period last year. Sales for the year-to-date period grew to $14.4 billion with comparable store sales up 4% over last year. For the third quarter at Ross, cosmetic, accessories and shoes were again the strongest performing businesses, while geographic results were broad-based. Like Ross, dd's DISCOUNTS shoppers also responded favorably to its strong value offerings, driving improved sales trends during the quarter. At quarter end, total consolidated inventories were up 5% versus last year, while average store inventories were up 2%. Packaway merchandise represented 39% of total inventories versus 41% in the same period of the prior year. During the third quarter, we also completed our expansion program for 2023 with the addition of 43 new Ross and 8 dd's discounts. Over the year, we added a total of 97 locations comprised of 72 Ross and 25 dd's. We now expect to end the year with 1,764 Ross stores and 345 dd's DISCOUNTS for a net increase of 94 stores. Now Adam will provide further details on our third quarter results and fourth quarter guidance.

Thank you, Barbara. As previously stated, comparable store sales rose 5% in the quarter, primarily driven by higher traffic. Operating margin increased 135 basis points to 11.2%. Cost of goods sold improved by 260 basis points in the quarter. Merchandise margin was the main driver with a 235-basis point increase, primarily from lower ocean freight costs. Distribution expenses improved by 45 basis points, mainly due to favorable timing of packaway-related costs. Domestic freight and occupancy levered by 40 and 25 basis points, respectively. Partially offsetting these benefits were higher buying costs that increased 85 basis points, mainly from higher incentives. SG&A costs for the period increased by 125 basis points, primarily driven by higher incentive costs and store wages. During the third quarter, we repurchased 2.1 million shares of common stock for an aggregate cost of $239 million. We remain on track to buy back a total of $950 million in stock for the year. Now let's discuss our fourth quarter guidance. We continue to face macroeconomic volatility, persistent inflation and more recently, geopolitical uncertainty. In addition, we are up against our most difficult quarterly sales comparisons versus 2022 in the fourth quarter. As a result and while we hope to do better, we believe it is prudent to maintain a cautious approach in forecasting our business and reiterating our prior sales guidance for the fourth quarter. For the 13 weeks ending January 27, 2024, we continue to plan same-store sales to be up 1% to 2%. Earnings per share for the 14 weeks ending February 3, 2024, are projected to be in the range of $1.56 to $1.62 compared to $1.31 in the fourth quarter of 2022. This guidance range includes an approximate $0.02 per share unfavorable impact from the timing of expenses that benefited the third quarter. Based on our year-to-date results and our fourth quarter forecast, earnings per share for the 53 weeks ending February 3, 2024, are now expected to be in the range of $5.30 to $5.36 versus $4.38 last year. Incorporated in this guidance for both the fourth quarter and full year is an estimated earnings per share benefit of $0.16 from the 53rd week in fiscal 2023. The operating statement assumptions that support our fourth quarter guidance include the following: Total sales are projected to grow 8% to 10%, including an estimated $260 million benefit from the 53rd week. We expect operating margin to be in the range of 11.3% to 11.5% versus 10.7% last year. This range includes a 65-basis point benefit from the extra week. We are planning for higher merchandise margins, given lower ocean freight cost, though moderating from the improvement earlier this year. In addition, lower domestic freight and distribution costs, partially due to favorable packaway timing are expected to benefit margin. Partially offsetting these lower costs are forecast for higher incentive compensation. Net interest income is estimated to be about $45 million as we continue to benefit from higher interest rates on our cash balance. Our tax rate is expected to be approximately 23% to 24%, and weighted average diluted shares outstanding are projected to be about 335 million. Now I'll turn the call back to Barbara for closing comments.

Thank you, Adam. Looking ahead, despite all the challenges in the external environment, we are encouraged by our healthy above-plan results to date this year. We also remain confident in the resilience of the off-price sector and our ability to operate successfully within it, especially given consumers' heightened focus on value and convenience. As a result, we remain optimistic about the company's future prospects and our ability to expand market share and profitability over time. At this point, we'd like to open up the call and respond to any questions you might have.

[Operator Instructions] And the first question comes from the line of Matthew Boss with JPMorgan.

Congrats on another nice quarter. So Barbara, could you elaborate on changes across categories that you've made to increase your value focus? It seems like that was a clear takeaway from your comments. Maybe also if you could speak to the cadence of traffic that you saw as the third quarter progressed? And just how you see your assortments positioned in the holiday to take share.

Matthew, I'll start with the traffic. As we said in the commentary, traffic was the primary driver of comp for the quarter on a stack basis. The comps were fairly consistent across the quarter with a couple of fits and starts late in the quarter regionally with weather as it always is this time of year. That said, for the entire quarter, weather was neutral.

And Matt, by change across categories, do you mean performance?

More the value -- I think you talked about a greater value focus starting in the second quarter. It sounds like it resonated further in the third quarter. So just maybe changes that you've made as it relates to that.

Well, the value changes that we made are across the entire box. So the merchants are out there really looking for great branded products where they can offer compelling values. So that's really -- it's not in any one area. It's across the box. Obviously, some businesses are further along than others as you would expect. But that's a company-wide focus now to offer the most compelling value to the customer at this time. And changes to the assortment of the fourth quarter or just share is really after gifting. We've expanded some of our products in gifting categories, which I wouldn't talk about on the call but it's really a focus on gifting.

Great. And then maybe as a follow-up, Adam, how best to think about merchandise margin recapture opportunity in the fourth quarter just given the environment a year ago? And any change in terms of flow-through in the model on 3% to 4% same-store sales as we think more multiyear.

Yes. On the latter part, no change in the flow through in the model, right? We still expect to lever on the 3% to 4% comp. And your question on merchandise margin was fourth quarter specific?

Yes.

Yes. So ocean freight, which we benefited from all year, will still be a benefit in the fourth quarter. But as we said in the call comments, we'll moderate considerably. We started to see pretty significant rate reductions about this time last year. So there'll be further benefit in fourth quarter, but not like we have seen in the first 3 quarters of the year. I would expect that really to be the main driver on merchandise margin. All other components should be pretty consistent with last year.

The next question comes from the line of Mark Altschwager with Baird.

Great. I guess, first, your plan for the fourth quarter top line hasn't really changed despite comps exceeding the high end of your plan by a couple of hundred basis points in the third quarter. Curious, does that give you more confidence in the upside case? Or are there things you've seen in recent trends that would suggest a more material quarter-over-quarter deceleration is the right expectation?

It's Michael again. I would say, for the most part, it's -- there's a lot going on in the external environment, whether it's a macro economy. We expect it to be a very promotional retail environment and now you have geopolitics into the mix, and it is our toughest compare for the year. So given everything going on externally, we think it's prudent to remain very conservative in running the business in the fourth quarter.

And maybe a follow-up for Barbara. The North American wholesale channel continues to be challenging for many vendors, given the dynamic macro. I'm curious what you're hearing with respect to product availability heading into calendar '24?

Well, currently, there's a lot of availability in the market, as I know you know that. Here's a look at availability at this point. Vendors -- in this environment, vendors are really looking for ways to increase their market share. And so they've shifted some of their business towards the growing retail channels. So if, in fact, they get less bookings, we talked about them having less bookings for fall and there's still availability. So bookings are one thing. Then how much they decide to bring in to drive market share or to shift channels is an other things. So I don't necessarily think they're the -- you can judge just by bookings what they say about their bookings. And therefore, frankly, there are some vendors that are really looking to gain market share in this period in time and are taking greater risk on bringing in more goods. So it's kind of a mixed bag but they're really looking to expand who they do business with and to shift channels. So I think that's the reason why goods continue to become available.

[Operator Instructions] The next question comes from the line of Paul Lejuez with Citigroup.

Sorry if I missed it, but could you talk about performance in the home category? And then also I was curious about store performance based on income, demographic, locations. Any change in terms of how any specific income cohort behaved during the quarter?

Paul, on the income, as we said in the commentary, the comp performance was fairly broad-based across geographies, but also what I'd say is trade area demographics, including income. So your bigger question is, are you seeing a trade down? We saw very broad-based performance across income levels.

And in terms of the home performance, home performed slightly below the chain average.

Got it. And then just a follow-up. On the merch margin, I think you mentioned freight is a big driver but can you talk about pure merch margin outside of freight? Just IMUs, markdowns, what the out-the-door merch margin was on a pure product basis?

Yes, Paul. I won't go through a component by component but merch margin in addition to the ocean freight benefit, but if you back ocean freight out of it, we were better than last year as we anniversary the markdowns that we took last year. So third quarter last year was kind of our peak quarter for incremental markdowns last year.

And the next question comes from the line of Lorraine Hutchinson with Bank of America.

What were the drivers of dd's improved sales trends during the quarter? And is that now running in line with Ross?

Sure, Lorraine. As -- dd's, as we said, also improved and were relatively in line with performance at Ross. We believe the improved performance here like it is at Ross is the customers responding to the broad assortment of values throughout the stores. And I'd also add easing inflation certainly doesn't hurt this customer.

And then any update on shrink from your recent physical inventory?

Yes. Lorraine, in third quarter -- so we took our second physical inventory over the year in third quarter and trued up those results, the results were in line with our expectations and in line with last year.

[Operator Instructions] The next question comes from the line of John Kernan with TD Cowen.

Excellent. Nice job in 3Q. Barbara, your buyers are obviously doing a great job passing on value to the consumer. I'm wondering how initial markup trends are as we -- as you focus on value?

Well, obviously, we're not going to talk about but IMU. But I think as the merchants are in the market and they are really looking for compelling deals, they obviously have metrics that they should hit, and I would say that they do that. But if there's a really unbelievable deal, we're going to price it the way we think we need to price it. Our strategy now is really to continue to deliver value. And so again, they have metrics, everyone is hitting their metrics, but that's the focus. What is the right price, what is the right value to drive the customer into the store to gain market share. So that's the hit that everyone does.

Understood. And Adam, when you look at the model, what do you think is the line item in either COGS or SG&A that has the most potential for improvement if you maintain the 3% to 4% same-store sales going forward?

We're just getting into the -- we're working our way through the planning process. We'll come back and talk at the end of the year and kind of frame up how we see the go forward at that point in time. I think just to give you some generalities, I feel like we've recaptured most of the ocean freight at this point. When we look at container rates now are very similar to where they were in 2019. So we think by the end of the year, we'll capture all that benefit. On the domestic side of freight, we've recaptured some but certainly not at 2019 levels, given the elevated fuel cost and elevated driver wages since 2019. So pushing very hard on the other components. We'll come back and tell you more about the puts and takes at the end of the year.

And the next question comes from the line of Chuck Grom with Gordon Haskett.

Congratulation. Can you provide color on the trend of basket size and the composition between AUR and UPT this quarter and if you see that changing going forward over the next few quarters?

Sure. And as we said, traffic was the primary driver of the 5% comp. Average basket was up just slightly as an increase in the units per transaction was partially offset by slightly lower average unit retails. And if we think about it going forward, we'd like to be driven by traffic but we don't plan our business around the components. We plan the business on offering the best value. And if we get traffic and a basket size increase, that's great for the business.

And the next question comes from the line of Brooke Roach with Goldman Sachs.

I was hoping you could discuss the puts and takes behind your SG&A growth now that we've moved through the periods of elevated incentive comp investment this summer. How should we be thinking about the growth of that line item going forward? And in particular, can you elaborate on what you're seeing in terms of store wage rate inflation?

Brooke, this is Adam. Yes. So store wage, as we said in the comments, they'll continue to put pressure on us. That's largely driven by minimum wage changes that we need to take in the marketplace. But I would say overall on SG&A, the biggest moving part this year has been incentive comp, right? So as you'll remember, very little incentive comp last year. And not only did we have to reset the bar this year but we're obviously outperforming our financial plan. So that's the biggest kind of volatility in the SG&A line.

I'll just add on the wage front. I mean, generally speaking, wages have stabilized throughout the stores and the DCs and any increases we're seeing are really driven by minimum wages. On SG&A going forward, I think we'd expect that we'd be able to lever between the 3 and 4 comp as we have in the past.

And the next question comes from the line of Michael Binetti with Evercore.

Congrats on a great quarter. I just want to ask, do you think -- Michael or Adam, jump ball, what do you think about -- what do you look at today to inform us whether there's some opportunity in the pure merch margin for next year, puts and takes that you're thinking about? Barbara, you mentioned seeing some -- you mentioned some great comments on some of the brand availability. Is there an opportunity for AUR as you guys get better access to quality brands? And then I noticed you opened a bunch of the handful stores in Michigan a few months ago and 1 single store in Minnesota. These are new markets, even though we've heard you guys talk so favorably about how the Midwest has gone since you launched it maybe 12 years ago. It Seems like you're starting to move into some new markets, some fairly big ones, maybe just some thoughts around the new market strategy.

Sure. On merchant margin for next year, we're in the middle of our planning process now. So I'd wait until our year-end call, and we can give you some more feedback on that. As you mentioned, we entered Michigan and Minnesota during the third quarter. It's very early on those. So hard to comment at this stage other than we're very optimistic about our new market growth..

And in terms of brands and AUR increase. Really, I know it sounds like I'm going back to same thing. We really are looking at every deal based on the value we put out on the floor. And so obviously, if they're higher on brand, those goods would -- even at great values would have higher AUR. But it's really a mix of all brands, whether they're moderate, they're better, they're good, better, best, where they're best. That's how we're really approaching it in terms of just saying I'm going to raise the AUR because we increased we [ debt ] in total. That's not how we're thinking about it. We're thinking about it more holistically, and that's the piece that customers responding to.

And the next question comes from the line of Adrienne Yih with Barclays.

Great. And I'll add my congratulations. Barbara, I often -- I am on the topic of your packaway and your short stay. Historically, when we have sort of disruptive weather and kind of like the unseasonable weather in the early in the quarter, you're able to use your short-stay flexibility to kind of pace into that. I'm just wondering how advantageous has that been this season? Or is the macro -- kind of more challenging macro sort of overwhelming that?

I just want to make sure I understand what you're saying. You're saying that did we get seasonal products early and [indiscernible] closing the fourth quarter?

Yes, yes. I think it's more that weather has not transitioned to cold for any long permanent period of time, so we're hearing frontline retailers talk about that lower their fourth quarters, and there's a disconnect between how much they've ordered and what things that they need to get rid of. So I'm wondering if that's been a benefit to you.

At this point in time, there's -- the goods are obviously building because the weather has been warmer than people anticipated. But there is a moment in time when vendors decide to really move the goods and that really -- becomes really more longer-term packaway. So if you're thinking outerwears, whether its classifications like that, that really would be longer term versus shorter term deals. I could still get deals in front of us. But really, that's really more of a longer-term play that vendors at the end of the year decided what they want to do when they're figuring out what they're going to buy for the next year. So short term, I think people are just coming to -- having a reality check of where they are with some of those classifications of products. So the real answer, I guess, is more news to follow. But at this moment in time, it hasn't been -- they haven't had a big movement if that's what you're looking for, a big movement on the...

And the next question comes from the line of Alex Starton with Morgan Stanley.

Great. Maybe for Barbara, some peers have highlighted opportunities in new or adjacent categories. So I'm just wondering, has Ross entered any newer categories recently? Or what kind of thoughts do you have on opportunities in general and then any changes in category mix shift that you guys have done?

Sure. Yes, we have entered into some new categories. Obviously, I'm not going to talk about it on the call. But yes, for the fourth quarter, we entered some different categories for gifting, which are going on the floor now and into December. And then just opportunities in general as we move into next year. I think we have some opportunities in expanding certain businesses and then also coming back into some businesses that we exited, I would say, sometime during COVID. So I think there is an opportunity for us to have more newness on the floor, which is really what the customer love plus value is really what the customers responding to. So every year, we go in and look and say, what else can we expand, what else can we do? But this year, we have, yes, we have our categories in mind if [ we were ] not in mind and where we are going to [ spring ].

And the next question comes from the line of Marni Shapiro with Retail Tracker.

Congratulations. And if I forget, best of luck for the holiday season. But I'm curious, just on dd's, if we can dig in a little bit there. Are you -- with people looking to trade down with their wallets a little tighter, are you finding that you are attracting more new customers into that brand and the traffic trends that drove the comp in the quarter, whether this -- was that also true for dd's? And then I recall dd's tends to have more -- a little bit more family focused, you tended to have a little bit more kids and toy focus even. I'm curious how you feel about the lead-up to holiday with the assortments and values there? And is that still the case in dd's actually?

Marni, on traffic. So traffic like Ross, the comp for dd's was entirely driven by traffic.

And then in terms of assortment, yes, it is a family-focused box and the dd's customer does have more children. So businesses like toys in the fourth quarter becomes very important [ for the toys ].

Also holiday dresses do you do that business as well in dd's ?

We do all those businesses. All the traditional businesses you would expect, you would expect holiday dresses, you would expect toys, you expect anything, also family photo shoots and then toys or other little things that they give to kids but...

And can I just ask a follow-up on that? Are you seeing at dd's that the customer is now coming to dd's for these big holiday events like for Halloween, for Christmas? Does that customer come to dd's more regularly? Is it part of their regular trip of stores to go to?

I think it's part of the regular stores to go to. And do they like seasonal products, Halloween harvest, Christmas. Obviously, Christmas is very big. Yes. dd's, I don't think they'll get up in the morning and say, I need to go buy some Halloweens. I think there is always [indiscernible] they're going to stores, they are seeing things that they like and I think it's simple purchases probably for everyone.

The next question comes from the line of Dana Telsey with the Telsey Advisory Group.

Congratulations on the nice results. Can you give some color on the regional performance and what you saw California, maybe Texas and any of the other areas? And then also on categories, I think last time -- on last quarter's call, you mentioned that apparel trailed but improved sequentially. What did you see this quarter?

Regionally, Dana, our largest markets, California was above the chain average. Texas and Florida were in line. And as we mentioned on the call, it was very broad-based across the country.

And then in terms of apparel, it's slightly trailed the chain average and the comps were relatively similar between Q2 and Q3, but they did exceed plan.

And the next question comes from the line of Aneesha Sherman with Bernstein.

So Barbara, as retailers and brands have been talking about clearing excess stock. Are you seeing any change in your inventory mix and your percent of closeout? Like through the year, are you seeing more importing and more upfront buying? And I have a quick follow-up for Adam. You mentioned labor costs and wages stabilizing. Can you talk about some of the new labor cost saving models you've been piloting like self-checkout and any updates you can share on the rollout of those?

On the self-checkout, we're in a very small number of stores. And as you can imagine, we're going very slowly to make sure we get it right. We're in about 100 stores right now, and we're going to continue to pilot the operating model that we have there, and we're very cognizant of the shrink environment, so we're going to go slow.

And then in terms of upfront versus closeouts, as the year progressed, I mean it's pretty similar. It can peak up and down a little bit in the fourth quarter. You have more home business, some of that's more DI, so that gets bigger versus the rest of the year. But I would say it's similar. I think closeouts have come across all year pretty much in most businesses. And so I think -- yes, I don't see a bigger shift. It could have gone up or down 2 or 3 points, but nothing major.

And Aneesha, just building on those comments, within our CapEx, we're definitely investing in technology, more automation in our distribution centers. We're spending money in our stores just to automate. A lot of our noncustomer-facing tasks in more efficient ways to take markdowns and check inventory and also just investing in more analytics in the business.

And the next question comes from the line of Corey Tarlowe with Jefferies.

Great. I was wondering if you could talk a little bit about what you saw in footwear? I'm not sure if you did highlight it or if I missed it, but it would be great to get color there.

Sure. Shoes, again, was one of our best-performing businesses. And that was pretty -- that was broad-based across all the shoes.

Got it. And then just as it relates to higher buying costs, I believe you highlighted. Could you discuss what drove that?

The higher buying was all incentive cost related.

And the next question comes from the line of Laura Champine with Loop Capital Markets.

It's really about California wage rates, not just with the minimum wage increase but also the fast-food wage increase slated for the new year. How much of that -- how much of a material impact do you think that might have on your expense lines for next year?

Laura, obviously, we've been tracking up in California for some time with their minimum increases there. It's been a competitive market for us for a long time. I think in regards to the fast-food workers, we'll have to see how that spills over, but we believe we recruit from a different pool than the fast-food industry.

That's helpful. If I could get a clarification of a general sense of what percentage of your employees -- of your store-level employees are in California? Will that line up with your store count?

It will be a little higher than our store count because those tend to be higher-volume stores but slightly above our store count, I would say.

And the last question comes from the line of Bob Drbul with Guggenheim Securities.

This is Arian Razai on for Bob. It looks like inventories are up 5 -- on a 5% comp increase. Could you please expand on packaways, given the great brand availability, the reason of packaways have been trending down a couple of percentage points below last year and every quarter this year? Any changes in approach, a factor of higher deployment of product? Is it like better inventory productivity at stores? Any additional color would be super helpful.

Really no change to how we're running packaway. Sometimes when your business is very good, and we've been chasing a lot of business this year [indiscernible]. So we've been in a constant chase. And the thing about packaways, when you're buying goods that you're going to hold, you have to be absolutely sure that the values are correct. So the merchants are very discerning in what they buy when they put in packaway because when you're bringing it back out, we want to make sure that the value is right. So I don't think there's any way to look at packaway, there's a lot of goods out there. It could be packaway, just put more goods into our packaway we could. I think it's a merchant's job to really put the best product in there at the best possible values, and we're focused -- very focused on value. And so I don't think there's anything to read into it. But We feel -- actually, we feel very good about our content in the packaway that we own this shift because there's been a lot of very good deals and a lot of good products out there. So we have plenty of money to buy packaway if we'd like to buy some, but that is really comes to the merchant team. It's their call on what they believe is the right value. And then that's why, therefore, can fluctuate that plus the chase that we had in sales in the quarter.

Got it. Got it. So would you say that the product this year resonates better with the consumer like from the value perspective?

You mean the packaway product or just products in general?

Just products in general.

I think the customer is really responding to the better values. Clearly, she's financially pressed. And even though inflation is easing, she's still under pressure. And so whenever you can give the customer a better branded bargain at an unbelievable value, she's going to respond, which is why we're highly focused on that, and that would therefore take us through stronger market share.

And ladies and gentlemen, there are no further questions at this time. I'd like to pass the call back over to Barbara Rentler for any closing comments.

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

And this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.