Near-Term Headwinds Present An Opportunity In Ross Stores Ross Stores' stock price is pulling back into a buying opportunity on weak results. While weak, the results still support a healthy capital return program.

If you are looking for a bargain in the Retail Sector Ross Stores (NASDAQ: ROST) is not it but it is a relatively safe dividend payer that also buys back shares. The stock trades at roughly 21.5X its earnings estimates which put it in line with peers like The TJX Companies (NYSE: TJX) and sector favorites like Walmart (NYSE: WMT) and Target (NYSE: TGT). The valuation, high relative to the broad market S&P 500, is deserved however because Ross Stores is a well-run, blue-chip quality, dividend-growing off-price retailer in a good position for the times. There are near-term headwinds impacting results and the outlook but those will aid the company over the long term. Inventories are bloating across the retail universe and that means bargains galore for Ross Stores and its inflation-afflicted clientele.

"We are disappointed with our sales results, which were impacted by the mounting inflationary pressures our customers faced as well as an increasingly promotional retail environment. Earnings came in above our guidance range primarily due to lower incentive costs resulting from the below plan topline performance," said Barbara Rentler, Chief Executive Officer.

Ross Stores Confirms Resistance On Weak Results

Ross Stores did not have a terrible quarter but it left something to be desired in terms of underlying strength and outlook. The $4.58 billion in net revenue is down 4.6% versus last year on a 7% decline in comp store sales but this is versus a 15% comp last year and last year's Q2 was the strongest quarter of the year. The bad news is that revenue missed the consensus on weaker traffic and increased discounting but there was some margin strength to offset the miss but even that news is tepid. The operating margin came in better than expected but still declined 80 basis points YOY on deleveraging, discounting, and higher freight costs. The salient point is that GAAP EPS of $1.11 is down YOY but beat by $0.11 and is ample enough to fuel a healthy capital return program.

The stock is yielding a comfortable 1.35% on a forward basis which is below payouts from Walmart and Target but in line with the broader market. The payout is about 35% of the earnings guidance as well and that is at the low end of the range and balanced by a sound balance sheet. The company is carrying some debt but it is well-managed and holding steady on a year-to-year basis and the cash position is strong as well. Cash is down from the peak but still sitting above the five-year average and inventories are up as well. Inventory surged over the past year, up 57% aided by a traffic decline that is expected to linger into the back half of the year but not impact the capital returns. The company also repurchases shares and bought back $235 million worth or about 0.7% of the market cap.

The news that caught the market's attention, however, was the guidance which was lowered to a range below the consensus. CEO Barbara Rentler said it was wise to take on a more cautious stance given the conditions which is both prudent and open the door to outperformance in the back half. The new target for FY GAAP EPS is now $3.84 to $4.12 versus the $4.08 projected by Marketbeat's analysts tracking tools. The takeaway is that expectations for Ross Stores' results have been in decline and may fall further which sets a very low bar for the company to beat.

"Given our first half results, as well as the increasingly challenging and unpredictable macroeconomic landscape and today's more promotional retail environment, we believe it is prudent to adopt a more conservative outlook for the balance of the year."

The Technical Outlook: Ross Stores Pulls Back From Peak

The retail sector got a lift from a batch of mixed reports and Ross Stores moved higher with it. That lift hit a ceiling a few days prior to the Ross Stores release and it has turned into a peak in the wake of it. The price action is down about 1.5% following the report and on track to retest support at the $87.75 level. If support is confirmed at this level the stock may enter a near trading range with $87.75 as the bottom. If not, Ross Stores' price action may return to the prior range with $87.75 as the top.