U.S. Markets close in 1 hr 7 mins

Citi Trends Is an Undervalued Small Cap That Must Be on Your Radar

- By Ishan Majumdar

Discount apparel retailer Citi Trends (CTRN) announced its results for the 2019 fiscal year on March 15. The company delivered a mixed performance, but its stock price took a sharp correction of more than 40% in the past few months.

Given valuation levels, is the small cap a good value pick?

More stores and more revenues, but ladies segment disappoints


Citi Trends is known to be a discount retailer in apparel, shoes, accessories and home decor. After opening 19 new stores, relocating or expanding eight stores and closing six stores in the current fiscal, management reported an increase of 1.9% in total sales to $769.6 million and an increase of 46.5% in post-tax net income to $21.4 million. This was largely a function of cost reduction initiatives and lower tax costs on account of the Tax Cuts and Jobs Act.

The good aspect of its results was that it achieved comparable stores sales growth of 1.6%, which was largely driven by double-digit growth in the home business. The accessories segment also showed a decent level of growth during the year, while the men's and children's segment had a flat trajectory.

Citi Trends continued to face a decline in the ladies segment, which remains its Achilles' heel. Revenues in this business dropped by 2% for the quarter, but earnings per share were acceptable at 59 cents, which was about 3 cents above analyst expectations.

Strategic initiatives for better cost control

Despite a weak second half, management successfully managed to increase its post-tax income on account of its strategic initiatives. The company tightly controlled its operating expenses, rolled out store-level merchandise planning systems in existing stores and also opened new stores. The merchandise systems implementation has started to improve the inventory turnover for the company. Management's goal is a 2-3% increase in comparable store sales and an overall increase of 6% in the top line over the coming three years while ensuring a better response time to fashion changes.

As a part of the cost reduction initiatives, the company is upgrading its packaging systems and thereby expects a reduction in payroll costs by almost $500,000 annually starting from the second quarter of the next fiscal year. The management has also engaged professional consultants in the fields of freight cost management and expense control to keep a strong control on the overall costs and identify other areas that have a potential bandwidth for cost reduction.

The stock is undervalued despite decent fundamentals

It is apparent from the chart that Citi Trends' stock price has been continuously correcting from the highs of $33.55 made in August, and has fallen by more than 40% to below $20 as of Friday. The reason is mainly poor market conditions in the apparel sector coupled with weak results in earlier quarters.

On Friday, the stock price is languishing around its three-year lows, which is also the reason the yield has shot up to more than 10%. It is worth noting that Citi Trends has a three-year revenue growth rate of 6.2% and a three-year Ebitda growth rate of 12.9%, with a decent net margin of 2.78%. The company is also operating without any debt and a good amount of cash balance for future store acquisitions.

The only thing that management has to do in order to achieve a better valuation is to streamline operations. There is immense scope for expansion in terms of the valuation multiples, as the stock currently trades at a price-earnings ratio of about 11.46 and an EV-revenue multiple of 0.21, which is certainly at the lower end of the spectrum.

Conclusion

Citi Trends is in an compelling stock with good cash reserves and an ability to borrow capital and fund expansion while maintaining strict control over existing costs. The valuations are very low, and it could become a good transformation story if the management keeps up its efforts. The stock appears to be a risky bet with the potential to provide multi-bagger returns over the long term. But investors will want to watch out for the actual execution of the management's initiatives before considering an investment.

This article first appeared on GuruFocus.