UBS Trims Ross Stores Estimates, Target Price; Sees Near-Term Comp, Margin Pressures

UBS has cut the estimates and price target of Ross Stores, Inc. ROST after an execution misstep resulted in retailer reporting lower-than-expected comp for the first quarter. Pleasanton, California-based Ross Stores said a merchandise assortment mishap with women's apparel led to flat traffic in the quarter. "While ROST sounds confident that the packaway women's inventory is better—and should support better women's sales trends in 2H—we expect some ongoing SSS & GM pressure as ROST works through weaker women's inventory in the near-term," analyst Michael Binetti wrote in a note. As such, Binetti cut his second quarter EPS view to $0.67 from $0.70, comp estimate to +3 percent from +3.5 percent and gross margin forecast to -5bp YOY from +20bp. The company guided second quarter EPS of $0.64 - $0.67 on an assumed 1-2 percent comp and operating margins of 13.8 - 14.0 percent. Despite reporting an in-line EPS, the first quarter number of $0.73 missed UBS' $0.76 estimate. Comparable store sales growth of 2 percent, despite coming in at the high end of guidance, was below consensus estimates of 2.4 percent. Gross margins were -10bp YOY (UBSe: +8bp, Street: -21bp). "We were disheartened by ROST's +2% SSS in 1Q16, after Marmaxx reported +6% SSS in 1Q—given the high correlation of ROST & Marmaxx SSS historically. We were surprised to see ROST transactions flat YOY given Marmaxx's +6% comps was traffic-driven," Binetti highlighted. The analyst felt that Marmaxx's comp growth was a significant positive for the value-driven offprice segment, especially after hearing that traffic was weak across dept stores. "Recent comments from retail peers about favorable weather on the west coast suggested upside to our 1Q SSS estimate for ROST—given 42% of its stores are in the western US (the highest in our coverage)," Binetti continued. But, the company raised its FY16 EPS guidance to $2.63 - $2.72 from $2.59 - $2.71 on an unchanged comp guidance of 1 to 2 percent. Meanwhile, UBS has answered some of the key questions of investors: Can ROST continue to get access to compelling inventory to drive sales? "Yes. Elevated d-store inventories create sufficient merchandise opportunities for offprice in the NT. In the medium-term, brands increasingly view offprice as a legitimate primary channel (where younger consumers prefer to shop)—and will likely continue producing for offprice directly." Can ROST return to mid-single digit comp growth? "We think so. We expect major offprice chains to remain share gainers from categories like US d-stores for the long-term. Robust availability of branded inventory should continue to drive traffic in the NT. And ROST SSS should benefit from the impact of new stores entering the comp base for several years (Ross only has 60% as many stores as Mamaxx US)." Are new cost pressures (like rising US wages) a concern for ROST? "Yes. Our analysis suggests ROST currently pays lower wages relative to peers, and has high exposure to states with the largest min. wage increases. ROST has already communicated a framework for wage increases, but further wage increases could be a material impact to EPS upside." On a concluding note, Binetti said he is Neutral on the stock, but believes ROST will be a long-term structural share gainer and should outperform mall retailers as they clear inventory and combat weak mall traffic. "That said, we see less margin upside to justify further relative P/E expansion while ROST absorbs the impact of rising store cost pressures (e.g. min wages)," said Binetti, who cut the price target on the stock to $57 from $60. At the time of writing, shares of Ross Stores fell 3.40 percent to $53.63.