We have downgraded our recommendation on Saks Inc. (NYSE:SKS - News) to Neutral from Outperform on the back of the overall uncertainty in the macroeconomic environment.
In addition, Saks has not been returning value to its shareholders by paying dividends for two years and does not even anticipate declaring dividends in the foreseeable future, even though it generates surplus cash.
The company didn't repurchase any shares of common stock during 2010 and 2009 either. It was only during August 2011 that the company repurchased and retired an aggregate of 3,537 shares at the total cost of $28.9 million. Saks' remaining availability is approximately 29.2 million shares under its 70 million authorized share repurchase program, as of October 29, 2011.
Due to the seasonal nature of the business, approximately 30% of Saks' sales are generated during the fourth quarter, and normally a large portion of its operating income is generated only during the fall season. Nevertheless, the company generated strong third-quarter 2011 earnings of 11 cents per share, which surpassed both the Zacks Consensus Estimate by 2 cents and the prior-year earnings by 5 cents.
Saks also incurred incremental SG&A expenses as well as targeted incremental media spending and employee benefit expense during the third quarter of 2011 to support the growth in Saks Direct. The company thus intends to be very strategic in its SG&A spending, inventory management and capital expenditure investments.
However, the company purchases a substantial portion of its inventory from foreign suppliers whose functional currency is not the U.S. dollar. Thus, the changes in the value of the dollar relative to foreign currencies may increase the company's cost of goods sold. If the company is unable to pass such cost increases on to its customers, consumption, gross margins and earnings would ultimately decrease.
Nevertheless, the company has been showing significant improvement in same-store sales growth for the last several months. It increased 9.3% in the month of November 2011, owing to strong sales in the categories at Saks Fifth Avenue stores such as women’s and men’s contemporary apparel, handbags, fine jewelry, men’s shoes, cosmetics and fragrances. Furthermore, Saks has projected same-store sales to progress at the mid-to-high single digit rate for the fourth quarter of 2011.
Saks also showed a gross margin expansion of 160 basis points to 44.2%, over last year’s third quarter rate of 42.6%, principally resulting from increased full-price selling and reduced promotional activity.
Even though we continue to be optimistic about the future of luxury retailing and believe that Saks is well-positioned for additional operating margin improvement over time, we believe that the economy is still weak. Therefore, the situation is considerably reducing the number of consumers who can afford to purchase discretionary items. It also hurts the confidence of those consumers who are employed but want to spend less, which makes the situation very difficult for all retailers. Thus, we have provided a long-term Neutral recommendation on the shares. Additionally, the quantitative Zacks Rank for Saks is “3”, indicating no directional pressure on the shares over the near term.
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