Stock at this department store could skyrocket in 2021
The COVID-19 pandemic has had a devastating impact on many businesses. Department stores were among the biggest losers due to their focus on selling clothing and their continued reliance on in-store sales, often in malls.
An American department store chain has in fact improved income year after year for two consecutive quarters, however: Dillard (DDS 1.13% ). Nonetheless, Dillard’s stock ended November down 36% year-to-date. As the retail sector recovers in 2021, that department store inventory could hit a multi-year high.
Inventory discipline leads to better results
The pandemic has forced Dillard’s to manage its inventory much more carefully than in the past. The retailer entered fiscal 2020 with inventory down 4% year-over-year. At the end of the first fiscal quarter in early May, inventories were down 14%. Dillard’s exited the fiscal second quarter with inventories down 20%. At the end of the third quarter, inventories were 22% lower year-on-year.
This rigorous inventory management has enabled Dillard’s to reduce liquidation discounts despite unusually low traffic in its stores. In the second quarter, the gross margin of retailers increased 2.4 percentage points year-on-year despite a 35% drop in retail sales. Dillard’s performance in the third quarter was similar: Retail sales fell 25%, but retail gross margin improved 2.1 percentage points year over year.
These gross margin increases – along with significant expense reductions – enabled Dillard’s to significantly improve year-over-year profitability in the second quarter. Profit rose again in the last quarter, although it was roughly stable compared to the third quarter of 2019 on a pre-tax basis. These results were impressive given the pressure from Dillard’s. With equal attention to inventory management, the retailer could potentially exceed its 2019 profits, even if revenues never fully return to pre-pandemic levels.
Dillard’s is a cash cow – and spends that money predictably
Last year, Dillard’s reported pre-tax profit of $ 114 million, excluding gains from asset sales. This resulted in a low pre-tax margin of 1.8%. Net income only totaled $ 111 million, or $ 95 million excluding gains on the sale of assets. However, Dillard’s free cash flow generally exceeds its net income by a large margin.
There is a simple reason for this discrepancy: Dillard’s closely manages capital spending. Non-cash depreciation expenses were recently around $ 220 million per year, but even before the pandemic Dillard was only spending $ 100-150 million per year on capital expenditures. This cautious attitude towards capital spending is wise given that the department store industry is in decline. Other department store chains that have invested more aggressively in their businesses have achieved low returns on those investments. As a result, their stocks have underperformed Dillard stocks over the past decade.
In recent years, Dillard’s has typically generated around $ 250 million in free cash flow per year. Its quarterly dividend of $ 0.15 per share will only cost it $ 14 million this year. This leaves the vast majority of its cash flow available for debt reduction and stock buybacks.
Between fiscal 2016 and fiscal 2019, Dillard’s repaid $ 257 million in debt and spent $ 724 million on buybacks. He has a very healthy balance sheet today, having finished the third quarter with just $ 581 million in debt. As a result, investors can expect the company to continue to spend the majority of its free cash flow on redemptions.
Dillard’s market cap is just over $ 1 billion. With profitability having equaled or exceeded 2019 levels in each of the past two quarters despite weak sales and vaccines on the way, there is a strong possibility that free cash flow will rebound to $ 250 million or more over the course of this year. fiscal year 2021. This would allow Dillard’s to reduce its counting share quickly, potentially triggering a short press this could cause the stock to rise.
A trader or a real estate company?
Many investors can be skeptical about buying a stock in a department store, no matter how strong its cash flow is. Dillard’s business has been in decline for several years. What if the pace of decline accelerates? Fortunately, Dillard’s offers investors an additional margin of safety due to its huge real estate holdings.
At the end of October, Dillard’s liabilities stood at less than $ 2 billion. Meanwhile, the company had more than $ 1.8 billion in current assets (mostly inventory): enough to settle almost all of its liabilities. In fact, shareholders own Dillard’s real estate with virtually complete freedom. These properties total 43.7 million square feet of owned store space (and thousands of acres of associated land), as well as 3.9 million square feet of office, distribution and distribution space. storage.
Dillard’s store real estate includes many locations in valuable Class A malls. But while most of its stores are not very useful for retail, many could be repurposed as last mile distribution centers. , in doctor’s offices or for many other purposes. Others could be demolished and the land sold to multi-family developers. At a very modest average valuation of just $ 50 per square foot, Dillard’s real estate portfolio would be worth nearly $ 2.4 billion, more than double the company’s current market capitalization.
No stock is a sure thing. Between Dillard’s surprisingly good results in Q2 and Q3, his history of strong cash flow and huge real estate holdings, however, the odds are ripe in favor of this department store stock.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.