Ross Stores Q2 2021 Earnings Call Transcript

AlphaStreet
Provided by AlphaStreet
August 19, 2021
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Operator

Good afternoon, and welcome to the Ross Stores' Second Quarter 2021 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, COVID-related costs 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 2020 Form 10-K and fiscal 2021 Form 10-Q and 8-Ks on file with the SEC.

Now, I would like to turn the call over to Barbara Rentler, Chief Executive Officer.

Barbara Rentler
Vice Chair and Chief Executive Officer at Ross Stores

Good afternoon. Joining me on our call today are Michael Hartshorn, Group President and Chief Operating Officer; and Connie Kao, Group Vice President, Investor Relations. We'll begin our call today with a review of our second quarter performance, followed by our outlook for the third 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 second quarter sales and earnings substantially exceeded our expectations. Sales benefited from customers' positive response to our broad assortment of great bargains. In addition, our results were bolstered by a number of external factors, including ongoing government stimulus, increasing vaccination rates, and a diminishing COVID restriction.

Earnings per share for the 13 weeks ended July 31, 2021 grew 22% to $1.39 on net income of $494 million. This compares to $1.14 per share on net earnings of $413 million for the 13 weeks ended August 3, 2019. Total sales for the quarter rose 21% to $4.8 billion with comparable store sales up a robust 15%.

For the first six months, earnings per share were $2.73 on net earnings of $971 million, up from $220 -- up from $2.29 per share on net income of $834 million for the same period in 2019. Sales for the first half of 2021 rose 20% to $9.3 billion with comparable store sales up 14%.

For the second quarter, Ross' sales trends across merchandise areas and regions were fairly broad based with children's and the Midwest performing the best. Additionally, dd's DISCOUNTS trends remained robust during the period as both sales and operating profit gains significantly exceeded our expectations.

At quarter-end, total consolidated inventories were down 5% while average selling store inventories were up 3% versus 2019. Packaway levels ended at 30% of the total compared to 43% for the same period in 2019 as we used a substantial amount of packaway merchandise to support ahead of planned sales. In addition, there were receipt delays due to supply chain congestion.

Turning to store growth. We now expect to open approximately 65 total locations this year, comprised of about 45 Ross and 20 dd's DISCOUNTS. As usual, these numbers do not reflect our plans to close or relocate about 10 stores. As mentioned in last quarter's call, in 2022, we expect to return to our normal annual opening program of approximately 100 new stores.

Now, Michael Hartshorn will provide further details on our second quarter results, third quarter guidance and updated outlook for the year.

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

Thank you, Barbara. As we previously stated, comparable store sales increased 15% in the quarter, mainly driven by a larger average basket with traffic up slightly versus 2019.

Operating margin was well above plan and up versus 2019 at 14.1%. Cost of goods sold decreased by 45 basis points in the quarter. Merchandise margins and occupancy improved by 80 basis points each, while buying costs declined by 10 basis points. Partially offsetting these items were higher distribution expenses, which grew 40 basis points, primarily from wage increases, while worsening industry-wide supply chain congestion drove higher freight cost of 85 basis points.

SG&A for the period rose 5 basis points as leverage from strong sales gains was offset by COVID expenses and higher incentives given our better-than-expected second quarter results. Total net COVID-related expenses for the period were approximately 45 basis points, the vast majority of which impacted SG&A.

During the quarter, we repurchased 1.4 million shares of common stock for a total purchase price of $176 million. We remain on track to buy back a total of $650 million in stock for the year.

Now let's discuss our third quarter guidance. As a reminder, our projections compare to the same period in 2019. Looking ahead, there remains much uncertainty on the sustainability of the positive external factors that benefited our first half results as well as the potential risks we could face from the spread of COVID variants and worsening industry-wide supply chain congestion.

As a result, we are forecasting comparable store sales to be up 5% to 7% for the third quarter, with earnings per share projected to be in the range of $0.61 to $0.69. The operating statement assumptions that support our third quarter guidance include the following. Total sales are projected to grow 9% to 12%. We expect operating margin to be 7.3% to 7.9%. This forecast reflects significant escalation of freight costs as well as higher distribution expenses. In addition, ongoing COVID-related costs are projected to negatively impact EBIT margins by approximately 45 basis points in the period. We plan to open 28 stores during the third quarter, consisting of 18 Ross and 10 dd's DISCOUNTS.

Net interest expense is estimated to be about $19 million. Our tax rate is expected to be approximately 24% to 25%, and weighted average diluted shares outstanding are projected to be about 354 million.

Based on our first half results and third quarter guidance, we now project full-year comparable store sales gains of 10% to 11% and earnings per share to be in the range of $4.20 to $4.38 compared to $4.60 in 2019.

Now, I'll turn the call back to Barbara for closing comments.

Barbara Rentler
Vice Chair and Chief Executive Officer at Ross Stores

Thank you, Michael. While we're pleased by the better-than-expected results we reported today, as Michael noted, there is a high level of uncertainty on a number of external factors and how they may affect our business over the balance of the year. That said, we believe we are well positioned as a valued retailer and remain confident in our ability to continue to deliver great branded bargains.

Moving forward, we remain optimistic about our prospects for continued growth in both sales and profitability over the longer term, especially given consumers' increasing focus on value and convenience. Moreover, the significant number of retail closures and bankruptcies in recent years further enhances our ability to gain additional market share in the future.

At this point, we'd like to open up the call and respond to any questions you might have.

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Operator

[Operator Instructions] Your first question is from the line of Lorraine Hutchinson from Bank of America. Your line is open.

Lorraine Hutchinson
Analyst at Bank of America Merrill Lynch

Thanks. Good afternoon. It's quite a different tone with the 2Q beat versus the 3Q guidance. I was just curious how much of these sales and margin pressures are you seeing today versus how much you're baking in just in case things get worse?

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

Kimberly [Phonetic], it's Michael. On the sales front, the guidance is really based on the high level of uncertainty and risks that could happen in the third and fourth quarter. And it's really based on the risks that the external factors that benefited the first half, how sustainable those are, and then also with the Delta variant and supply chain congestion, what other risks exists. That said, we hope to do better than the guidance as we have year-to-date thus far.

Operator

Your next question is from Mark Altschwager from Baird. Your line is open.

Mark Altschwager
Analyst at Robert W. Baird

Good afternoon. Thanks for taking my question. So a lot of focus out there on kind of the cost side of the current kind of supply chain backdrop. Just hoping you could speak to some of the opportunities this is creating or expected to create in the months and quarters ahead, just with canceled orders, late deliveries, inventory trapped at nodes, kind of throughout the system. Just how do you see this really playing out from an inventory availability standpoint in the coming quarters? Thank you.

Barbara Rentler
Vice Chair and Chief Executive Officer at Ross Stores

Well, listen, obviously, the supply chain congestion is causing all kinds of receipt delays right now, and we expect those actually to worsen as the year goes on. So at some point in time, those goods will back up and we will see those as potentially an opportunity either for packaway or to flow depending upon business or what the types of products are. So, at this moment, you would think that, that would happen probably either late in the year or at the beginning of next year, if I had to pick a timeframe.

Operator

Your next question is from the line of Paul Lejuez from Citigroup. Your line is open.

Paul Lejuez
Analyst at Smith Barney Citigroup

Hey. Thanks, guys. Can you maybe talk about performance by state? Curious, your three big states, how different the performance was in the second quarter? And also curious if there are any states in particular where you might be seeing some sort of change in trend in the third quarter to date that's kind of guiding how you are thinking about comps in 3Q. And I was also curious if you could just talk about home versus apparel performance in the quarter. Thanks.

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

On the regional performance, so Texas, Florida, California, they make up about 50% of our sales. What we saw during the quarter, Texas and California were relatively in line with the chain. Florida, which trailed in the first quarter, saw a significant improvement as tourism increased, though still a bit below the chain in the second quarter. And we wouldn't comment on current quarter trends at this point.

Barbara Rentler
Vice Chair and Chief Executive Officer at Ross Stores

And home versus apparel, home continues to be one of our top-performing merchandise areas, similar to trends that we've seen throughout the entire pandemic. Apparel, however, continued to accelerate from Q1 to Q2. So, I think what we're seeing in apparel is, pre-COVID, there was already a shift towards casual wear and then activewear, and what's happening now is that more traditional sportswear classifications have also improved. So that's starting to make -- to build the sales from one quarter to the other.

Paul Lejuez
Analyst at Smith Barney Citigroup

And Barbara, are you seeing the supply chain disruption impact certain categories more than others? Anything you can share there?

Barbara Rentler
Vice Chair and Chief Executive Officer at Ross Stores

Look, overall, there is plenty of supply. It's not consistent to your point across merchandise departments, but in reality what's happening is that merchandise deliveries are sliding. So it could slide two weeks, 30 days. They are sliding, and so what the merchants are really doing is they are constantly flexing based off of what they are seeing in the market, the availability and they're chasing into classifications that they need. So it's a little bit -- it's a little bit of a moving target. But overall, there is plenty of supply.

Paul Lejuez
Analyst at Smith Barney Citigroup

Okay. Thank you. Good luck.

Operator

[Operator Instructions] Your next question is from the line of Kimberly Greenberger from Morgan Stanley. Your line is open.

Kimberly Greenberger
Analyst at Morgan Stanley

Okay. Great. Thank you. I wanted to hear if you've given any further thought to potentially some price actions just to help absorb some of the higher costs, even if it's just a little bit here or there or sort of surgically done based on what comparison prices you're seeing in the marketplace?

I just wanted to see if you had thought about that any differently as compared to your comments back in May. And then could I just get a clarification on the full-year 10% to 11% comp guidance? And what does that embed for the fourth quarter? Thank you so much.

Barbara Rentler
Vice Chair and Chief Executive Officer at Ross Stores

Okay. In terms of pricing, Kimberly, we still strongly believe that price value is critical to our customers. So as you know, we, over the years, talked about how the merchants comp shop regularly. And really -- they really understand that our target shopper is really price savvy. So if she's not getting the best deal out there, she knows it. The higher prices at traditional retailers could increase the pricing gap that we offer and strengthen the values that we provide to our shoppers. And quite frankly, the merchants are constantly making those price value assessments of their assortments all the time.

They're prioritizing, as we'll always prioritize, really having sharply priced assortments for our entire store. So at this point, I wouldn't talk anything more about it for competitive reasons. But the one comment that I would say is we won't be the leader in terms of raising prices. The merchants will do their job and they'll assess it, and they'll price it the way they see it.

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

Kimberly, on comp guidance, the fourth quarter looks very similar to the Q3 at this time [Phonetic].

Kimberly Greenberger
Analyst at Morgan Stanley

Thank you.

Operator

Your next question is from Chuck Grom from Gordon Haskett. Your line is open.

Chuck Grom
Analyst at Gordon Haskett

Hey, thank you very much. Good quarter. Just wondering if you guys could speak to the magnitude of the DC and freight costs that you're anticipating in the third quarter. It looks like over the past couple of quarters, it's been about 100 basis point to 125 basis point drag. Just wondering if you could speak to how big of a drag you're expecting here in this quarter. Thank you.

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

We didn't give specific guidance. In the second quarter, obviously, DCs were 40 basis points of drag and freight was 85 basis points. So, we would expect both the DCs and the freight costs to worsen in the back half, some of that's driven by the leverage on comp. But we would expect -- we've raised wages further in the DCs, and we're seeing specifically ocean freight costs significantly escalate in the back half. So, those expectations for worsening are built into the guidance that we gave.

Operator

Your next question is from the line of Matthew Boss from J.P. Morgan. Your line is open.

Matthew Boss
Analyst at J.P. Morgan

Great. Thanks, and congrats on a nice quarter. So, Barbara, any early thoughts on overall back-to-school trends, maybe what you've seen so far in August in some of the states that have gone back earlier? And then, Michael, on gross margin, have you embedded any change in the external promotional or pricing backdrop for the third quarter relative to what we saw in the front half of the year just in your merchandise margin outlook?

Barbara Rentler
Vice Chair and Chief Executive Officer at Ross Stores

So Matt, the back-to-school trends, look, we've been pleased with our younger businesses performances for a while, and so that obviously bodes well for back-to-school. In terms of classifications, I would say the customer is still buying wear now, but has started to make that conversion to go forward in a more traditional back-to-school fashion that we might have seen from a product perspective in, let's say, 2019. But we feel good about those businesses because, obviously, our younger businesses are doing well. Therefore, back-to-school, we feel pretty good about.

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

And, Matt, on margin, obviously, we had built in what we can see today with our current [Phonetic] on order. I think our big opportunity as it was in the second quarter is, if we can exceed these sales plans there, there should be a benefit as we turn faster and take lower margins.

Operator

Your next question is from Janine Stichter from Jefferies. Your line is open.

Janine Stichter
Analyst at Jefferies & Co.

Hi. Thanks for taking my question. Wanted to ask you about the COVID costs, if you had any thoughts about the timeline for potentially starting to moderate the expense you're putting into the cleaning and sanitation aspect in the stores? Thank you.

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

Sure. I think that's changed over time. Obviously, if you would have asked me that two months ago, it would have been sooner than later. But right now, we have the cleaning aspects built-in throughout the rest of the year, which we think is appropriate given the variant spread.

Janine Stichter
Analyst at Jefferies & Co.

Got it. Thank you.

Operator

Your next question is from Michael Binetti from Credit Suisse. Your line is open.

Michael Binetti
Analyst at Credit Suisse Group

Hey, guys. Thanks for taking our questions here. Michael, I'm curious, what you think are the biggest opportunities to get the business, if we try to look beyond a lot of the noise in the margin right now, to get the business back to that kind of 14%-plus operating margin that you guys saw a few years back.

It sounds like you -- I guess, when you look at the pricing commentary in the softlines group, you seem to think that there is no real urgency here to move towards it. So maybe that's -- maybe that implies your thinking that some of these costs we're seeing are quite transitory. Do you -- within that -- if that's right, what do you think are the best ways for this business to get back to that 14%-plus operating margin in the past from here?

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

Sure, Michael. As you mentioned, obviously, we have transitory costs in the business right now, whether it's COVID. At some point, there will be some equilibrium in the freight world, especially with ocean freight that we expect to be an opportunity going forward. And then I would say the return to 2019 margin levels will be highly dependent on strong sales performance over time.

And given we're in a very vibrant sector of retail, there's market share up for grab with store closures and bankruptcies. And the customer who is focused on value and convenience, we feel good about our opportunities. Now, that is not to say that we don't have a lot of work going on in the business to find places to be more efficient to offset some of these costs, but I think it's dependent on how long some of this inflation lasts and then certainly on the topline growth.

Michael Binetti
Analyst at Credit Suisse Group

Thank you.

Operator

Your next question is from John Kernan from Cowen. Your line is open.

John Kernan
Analyst at Cowen and Company

Excellent. Thanks for taking my questions. Just curious on the quantification of freight and distribution headwinds into next year. Is this -- the impact that you're guiding to in the back half of the year, is that ballpark? How we should think about it for the first half of next year?

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

I wouldn't comment on next year at this point. In the DCs, the wages that we've made are permanent. And that said, we do have productivity initiatives that we'll build into our budgets and plans for next year. On the freight cost, I'd say, it's hard to say at this point. I gave you my view at this point. I think some of the ocean and congestion will bleed into the first part of next year.

John Kernan
Analyst at Cowen and Company

Got it. One quick follow-up. Just as we stay on the theme of supply chain here, are you concerned at all about deliveries into holiday in early part of next year, given some of the things we're seeing at ports, etc.?

Barbara Rentler
Vice Chair and Chief Executive Officer at Ross Stores

Well, I think, look, we all know there's supply chain problems and it's backed up and all the issues with COVID overseas, which kind of made all of the -- not all, but a large majority of goods coming out of China slide. I think the issues are real, and I think they'll continue for a while. And so what we have to do is really make sure that we're paying attention to what it is and that the merchants are adjusting and flexing based off of what they're seeing and what's happening around them. I mean, the majority of our business is closeouts.

So, a lot of these things are a timing issue of how goods will slide, what goods might be late that might be available for us to buy in season. It's kind of like a moving target. I think the challenge as you go into Q1 is that Chinese New Year is a couple of weeks earlier. So, those two things are going to slide, I think, a little bit in terms of deliveries and the kind of goods that have to get out of China in particular.

So, I think the answer is we're going to watch it, we're going to adjust as we go. And we're in a flexible business model, so as long as we can offer a treasure hunt and a broad assortment, that's we're going to do.

John Kernan
Analyst at Cowen and Company

Excellent. Thank you.

Operator

[Operator Instructions] Your next question is from Adrienne Yih from Barclays. Your line is open.

Adrienne Yih
Analyst at Barclays Capital

Yes, thank you very much. Barbara, I was wondering if you had seen any changes in basket or ATV this quarter versus first quarter? And then towards the end of the quarter, were you've seen any impact in particularly Texas and Florida of maybe the Delta variant on late July trends? I know that for a quarter, they seem to be fine, but any trailing off at the end of the quarter? Thank you very much.

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

Adrienne, on the components of comp, it was mainly driven by the size of the basket. Traffic was up slightly. And the basket was driven -- AUR was up slightly, but it was basically driven by units per transaction, and that was a consistent trend with comps throughout the quarter. We wouldn't say specifically the sequential trend other than to say it was fairly robust throughout the quarter. May was slightly higher than the other months in terms of absolute comp.

Adrienne Yih
Analyst at Barclays Capital

Thanks very much, and best of luck. Congrats.

Operator

Your next question is from the line of Marni Shapiro from Retail Tracker. Your line is open.

Marni Shapiro
Analyst at Retail Tracker

Hey, guys. Congrats on a great quarter. Could you -- I just want to clarify one thing, Michael, that you said. You said Texas, California and Florida made up what percent of your sales? You guys used to talk about this in the past, I just want to clarify the number that I heard.

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

It's about 50% of our business.

Marni Shapiro
Analyst at Retail Tracker

That's what I thought. Can we talk just a little bit about marketing? I know it's not a big ambitious push for you guys like it is for other retailers. So, I'm curious just through COVID coming into this year, where was your marketing spend, has it ticked up through this year as the stores have all now, for the most part, being opened? And have you been spending against that? Or has demand been so strong that you haven't ticked up the marketing? And how should we think about it in the back half of the year? If you could just talk a little bit about that.

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

In terms of marketing, for competitive reasons, we wouldn't provide the details there, Marni. But we have made strategic investments, we made channel shifts, and we have used -- put more money into places like digital versus broadcast. So, we have made some shifts during COVID, and we'll continue to find what works best for us going forward.

Marni Shapiro
Analyst at Retail Tracker

Has it picked up? Now that the stores are open compared to a year ago, when, say, the first half of the year, for sure, stores were...

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

No doubt -- yeah, Marni, no doubt about it. We -- when the stores were closed, we obviously took it as an opportunity to not spend when the stores were closed. So it certainly has picked up versus last year.

Marni Shapiro
Analyst at Retail Tracker

So that's all rolled back in here. Okay. And it should be about your usual levels then from here out without[Phonetic] the stores opened?

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

That's correct.

Marni Shapiro
Analyst at Retail Tracker

Okay. Fantastic. Thank you. Best of luck with the rest of fall season.

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

Thank you, Marni.

Barbara Rentler
Vice Chair and Chief Executive Officer at Ross Stores

Thanks.

Operator

Your next question is from Laura Champine from Loop Capital. Your line is open.

Laura Champine
Analyst at Loop Capital

Thanks for taking my question. I'm still trying to get my head around the significant decline, almost 50% sequentially in EBIT margins that you're sort of looking to in Q3. I certainly heard the 45 basis point of COVID costs. But are you expecting a big reversal in merchandise margin? Or what are some of the assumptions embedded within that EBIT margin assumption?

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

On the EBIT margin in -- between Q2 and Q3, for instance, obviously, the 5% to 7% comp is lower than our year-to-date performance at 15% in the second quarter. So, that drives a significant portion of it. And then as I mentioned, ocean freight costs where we've embedded the assumption that, that will significantly escalate over Q2, and then we expect higher wages in the DC to drive a bit more deleverage than we had year-to-date.

Laura Champine
Analyst at Loop Capital

Got it. Do you have -- can you give me total logistics costs as a percentage of sales sort of normally and where it's tracking now?

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

That's not something we provide, Laura.

Laura Champine
Analyst at Loop Capital

Got it. Thank you.

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

The best guidance I can give you at this point is, again, freight was 85 basis points for us in the second quarter and we've embedded significantly escalation from that. And then on the DCs, as I mentioned, it was 40 basis points and we expect additional deleverage because of higher wages.

Laura Champine
Analyst at Loop Capital

Got it.

Operator

Your next question is from Dana Telsey from Telsey Advisory. Your line is open.

Dana Telsey
Analyst at Telsey Advisory Group

Good afternoon. It seems like for a couple of quarters in a row now, dd's has had terrific performance. Anything to note there? And any changes to their plans in terms of what's driving that? Or is it the child tax credits and stimulus?

And then secondly, just on packaway, I think it's 30% this quarter, I think it was 34% in the first quarter. How do you -- how are you thinking about packaway for the balance of the year and the rate it would be at? Thank you.

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

Sure, Dana. On dd's, as we mentioned, dd's continue to have a robust sales trend like Ross EBIT margin improvement. I'd say, relative to Ross, it's been fairly consistent throughout the pandemic. Obviously, the external stimulus has impacted the dd's customer, but also helped the Ross customer as well. The one thing they have in common, though, is that, that customer is very focused on value and they've been attracted to what we've had added in the stores. So no changes that I would note in the second quarter.

On inventory levels, as you mentioned, packaway was at 30% of our total inventory. With ahead of planned sales, we obviously used some of that inventory to fuel some of the sales growth. It was also impacted by receipts -- delayed receipts. So within the inventory number, we have a higher level of in-transit than we have had historically. And then the return -- we would expect to return to historical levels over time, but that's going to be somewhat dependent on how we perform on the topline and whether we beat the plan and then also what supply chain congestion looks like at the end of the year.

Operator

Your next question is from Simeon Siegel from BMO Capital Markets. Your line is open.

Dick
Analyst at BMO Capital Markets

Hi. This is Dick [Phonetic] on for Simeon. I'm just wondering if you could give some color potentially on where you're seeing the most opportunity to kind of capture that share, if that's with new customers or with expanding the current customer wallet within the current dd's and Ross customers and kind of what you're thinking about that going forward?

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

Yeah. I would say what we've seen during the pandemic is we've seen a younger customer, part of that early on in the pandemic was driven by the older customer with restrictions and hesitancy to shop. As we moved along, we've seen in the customers that, that older shopper is actually returning back to the store. So, I think we have an opportunity across our customer base to the extent that we can provide them the bargains that they've come to expect.

Dick
Analyst at BMO Capital Markets

Great. Thank you.

Operator

Your next question is from Jay Sole from UBS. Your line is open.

Jay Sole
Analyst at UBS Group

Great. Thank you. Michael, is it possible to quantify for us the magnitude of the worsening of the inflationary pressures that you called out between Q2 and Q3?

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

Yeah. I would only just point to the overall EBIT margin. It's a significant de-escalation right now. The 7.3% to 7.9% is 4.50% to 5.10% versus 2019 of deleverage. So the main drivers out of that are obviously the comp difference between Q2 and Q3. The higher ocean freight is a significant portion of that and then as I mentioned, the higher distribution costs. I'd say the largest single deleverage is coming from ocean freight.

Operator

Our last question is from Roxanne Meyer from MKM Partners. Your line is open.

Roxanne Meyer
Analyst at MKM Partners

Great. Thanks, and congratulations on a solid 2Q. My question is on the merchandise margin. You delivered a very robust gain there on top of the sizable gain in the first quarter and really on top of a significant increase in merch margin last year. Where is that coming from? Is that being helped by just utilizing packaway? And how should we think about merchandise margin going forward?

Michael J. Hartshorn
Group President and Chief Operating Officer at Ross Stores

Yeah. In the quarter, really the upside versus our original expectations on gain versus last year is that we've been able to operate in a -- with inventory very close to need. We've operated with lower inventories in stores. We've been able to chase the business. And that has driven faster turns and lower markdowns. What we've done throughout the pandemic is tried to operate very close to need. And we think that we can do that not only during the pandemic but post-pandemic, which will benefit margins in the future. But the lower markdowns and faster turns was the main driver of the margin improvement in the second quarter.

Operator

There are no further questions at this time. I would now like to turn the call over to Barbara Rentler for her closing remarks.

Barbara Rentler
Vice Chair and Chief Executive Officer at Ross Stores

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

Operator

[Operator Closing Remarks]

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