Ross Stores: "Only" good earnings, or a recession signal?

One of the less exciting, yet moderately important U.S. companies reporting earnings today was Ross Stores.

Ross Stores operates several discount retail chains, meaning stores aimed at less affluent customers. Ross Stores’ stated and target customer group is “middle income,” but looking at the U.S. retail landscape, the USD 80,000 to 90,000 annual income bracket that dominates among Ross Stores customers is hard to describe as “middle income” in the current environment.

Earnings

The headline financial figures were good, though meaningfully distorted.

• Revenue rose to USD 6.3 billion, slightly above the consensus of about USD 6.15 billion.
• Comparable sales (like for like) increased by 10%. The report indicates this growth was a mix of higher engagement from existing customers and an influx of new ones.
• EPS (GAAP) came in at USD 2.66 versus the USD 1.94 consensus. Crucially, USD 0.60 of that total came from a refund of customs duties. After adjusting for this, EPS beat consensus by 6%, not 37%.
• Despite the significant impact from tariffs, operating margin improved organically by 205 basis points, so the company showed a real, not merely on paper, improvement in operating efficiency.

Investors reacted most positively to the clear upward revision of growth forecasts for the coming quarters. This reflects noticeably higher traffic in the company’s stores.

Ross Stores price chart (D1)

In the context of Ross’s own rally and potential positioning for a “recession,” a retailer with “only” a decent growth pace and a P/E of around 33 suggests that a meaningful premium tied to a weakening consumer is already priced in. Source: xStation5

Macroeconomic implications

More interesting than the results themselves are the macroeconomic observations suggested by the latest quarter’s results from retailers and consumer companies. Two important trends are visible, and they closely mirror what is happening in the broader economy.

Budget retailers such as Ross and Target handled earnings well. Mid to upper mid priced brands also did well, such as Estée Lauder. Meanwhile, previous market leaders like Walmart and Costco fell sharply after earnings. Why?

In July, U.S. retail sales declined by 0.6% month over month, the first drop in nine months. At the same time, they were 5% higher than a year earlier. Earlier data pointed to continued growth in real consumption, but also a decline in the savings rate to 2.7%. This means demand remains resilient, although households’ financial buffer is shrinking.

In such a situation, companies that offer households the best price to quality ratio benefit, as do “aspirational” brands focused on customers who are not yet under financial pressure.

As with retailers’ earnings, everything suggests that consumption growth is becoming lower quality and more fragile. Cost pressure from expensive gasoline, which affects consumers as well as distributors and producers, will only reinforce the current trends.