Discount retailer Ross Stores (click ticker for report: ) reported strong second quarter results Thursday morning. Revenue grew 12% year-over-year to $2.3 billion, driven by quarterly same-store sales growth of 7%, which was in-line with expectations. Earnings grew 27% year-over-year to $0.81 per share, in-line with the Street’s estimates. Ross provided its typically weak same-store sales guidance, estimating same-store sales growth of 3-4% in its third quarter and 1-2% in its fourth quarter. Management did boost full-year earnings guidance to $3.36-$3.44 from its previous range of $3.26-$3.37. Our fair value estimate remains unchanged.
The firm’s record operating margin of 12.8% shows the company’s commitment to boosting profitability at its existing stores. Increased security, both via greater personnel and technology investments, has helped reduce shrink to what management thinks is nearing the best it can achieve. Though management cited increased transactions as the main driver of same-store sales growth, they also noted increased average transaction sizes. We theorize that pricing may benefit slightly from the weakness in its department store competitors, as well as the shift towards brand names. Interestingly enough, management said approximately 90% of its stores are within 10 miles of a JC Penney (click ticker for report: ) location. While they wouldn’t say Ross is necessarily stealing share from JC Penney, it’s obvious to us that the variance in same-store sales between the two firms suggests that it is stealing share from the beleaguered retailer.
We’re fans of the discount retailer’s business model, and we think it will continue to benefit from shifts in consumer tastes. Competitor TJ Maxx (click ticker for report: ) reported similarly strong revenue and profitability growth earlier this week, so we think the retail giants can peacefully coexist. Ross is still in the early innings of its growth plan, as it operates just under 1,100 Ross Stores and believes the market can support an additional 900 outlets. Other than Chicago, Ross has yet to really penetrate the Midwest, and the company hasn’t even started populating the Northeast.
Though the company has an additional $450 million left to repurchase shares, we aren’t huge fans of its valuation at current levels. Admittedly, we think the firm has an excellent business model, but competition from TJ Maxx and Nordstrom Rack (click ticker for report: ) are heating up. We think shares are slightly overvalued at current levels, but we wouldn’t establish a short position on the firm. Ross is simply executing too well, and the firm’s underlying fundamentals remain strong.