My great-grandfather owned a small department store in the Pacific Northwest. With the help of my great -grandmother (who, I am told, watched the cash register like a hawk), they built a successful business -- which they sold before the onset of the Great Depression.
From what I can piece together, my great-grandfather was a shrewd merchant -- but I'm thankful the family got out of the department store business back then. Today, I don't think we'd be as lucky.
Two years ago, I gave the bear case for J.C. Penney (NYSE: JCP). (Last week, my colleague David Sterman gave a bullish take.) Back then, JCP traded at around $27. Today, the stock is treading water just above $6.
Granted, most of J.C. Penney's wounds seemed mostly self- inflicted due to the hedge-fund-controlled board selecting a CEO with zero department store experience who tried to radically revamp the entire franchise and wound up alienating the store's well-established core demographic. However, the company (and the department store sector as a whole) had been in critical condition prior to the stumble.
Face it. Big department stores are a dying breed -- and I've found the next casualty.
My wife's recent visit to our local Dillard's (NYSE: DDS) department store inspired me to write this piece. In contrast to when my wife and I were kids and a trip to the department store was a glamorous affair, she described a dingy store with tired, unmotivated employees. I decided to see for myself.
My oldest son is 14 and seems to outgrow clothes overnight. He needed a blazer for a school function, so I made an after-work trip to the same store. But I didn't encounter unmotivated employees -- in fact, I didn't encounter ANY employees. I couldn't find anyone to help me.
I also found a lot of inventory taking up space. As anyone who knows retail can tell you, that's expensive and unprofitable.
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So, naturally, I decided to dig into the stock. On the surface, it doesn't appear as dreary as the product. Looking at the chart, investors have made money over the past four years. The stock has charged on average 200% a year:
Sounds great -- but I don't think it's sustainable. Those who have made money should get while the getting is good.
While analysts try to put a positive spin on Dillard's fourth-quarter report, the numbers are thoroughly unimpressive. Comparable-store sales grew at an anemic 2%, and gross margins were squeezed by large markdowns on merchandise during the period.
Even more troubling is that inventory for the company increased 4%. That's the wrong direction: A retail business has to move the merchandise. Analysts also foresee a $26 million increase in overhead expenses due to the planned opening of four new stores this year.
In recent years, Dillard's bottom-line results have been inconsistent.
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Granted, it's been an impressive five-year slog from a loss to profitability, and the consumer environment is truly challenging. However, I'm of the school that believes that long-term investing success is predicated on clear, visible, consistent financial results. And if a dividend is involved, that consistency is vital to the sustainability of that dividend.
Dillard's currently pays an annual dividend of $0.24 a share for a meager yield of 0.26%. No big deal? Well, take into account that the company's payout ratio (the percentage of retained earnings paid out in the form of dividends to shareholders) is 76%, my rule of thumb is a payout ratio of no more than 60%, and it is a big deal. This demonstrates how weak the company's earnings power truly is.
Forward estimates call for 2014 earnings per share (EPS) of $7.89, which gives the stock a modest forward price-to-earnings (P/E) ratio of around 11. If the company were to achieve that number, that would be EPS growth of 15% over 2013 EPS -- but I just don't think management is capable of that.
'Don't Go Against The Family...'
This quote in the classic film "The Godfather" demonstrated how close-knit and strong the Corleone empire was -- but it could also describe Dillard's corporate governance.
|While analysts try to put a positive spin on Dillard's fourth-quarter report, the numbers are thoroughly unimpressive. Comparable-store sales grew at an anemic 2%, and gross margins were squeezed by large markdowns on merchandise during the period.|
The Dillard family still occupies the C suite and controls the board. They own a little more than 6% of the outstanding stock. What's more, Dillard's corporate governance includes a poison pill that was not approved by shareholders. By definition, a poison pill is a strategy used by companies to discourage hostile takeovers by making its stock less attractive to the acquirer.
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The company's dual-class capital structure also gives the Dillard family voting control over the stock. So, basically, a minority interest controls the company.
As far as what the future holds for Dillard's, investors could look to J.C. Penney, whose fall has been what I would call institutionally motivated: Institutions own nearly three-quarters of the company.
At one point, hedge fund honcho Bill Ackman was the biggest. Once Ackman gained control of the board, things went south for the venerable department store, whose business was already sagging amid a sour economy and a changing retail landscape. Ackman's activism was a catalyst for a looming death spiral.
In comparison, 88% of Dillard's outstanding shares are owned by institutions. The largest is event-driven money manager Evercore Partners (NYSE: EVR), with 25%. Yet those shareholders can't vote.
I understand that founding families are proud of the business they've grown. But this pride can often hurt the long-term viability of the business -- especially if the company is publicly traded. If you want to be a private company, go private. A $4.5 billion money manager that owns 25% of your outstanding stock isn't going to put up with the non-ability to vote for very long.
Risks to Consider: Selling a stock short is a complex investment strategy that involves an enormous amount of risk that few individual investors are equipped to deal with. Sophisticated investors may be able to take advantage of a decline in the price of a stock through owning put options.
Action to Take --> At nearly $92 a share, Dillard's shares look extremely overvalued. Based on its inconsistent earnings record, slowing sales and rising inventory, the earnings growth projected looks unattainable -- which means the price of the stock is unsustainable. Furthermore, the company's lopsided corporate governance policy that favors the founding family at the expense of regular shareholders causes also diminishes confidence. Investors who currently hold DDS should take profits, and investors who are considering buying DDS should avoid. Short interest for DDS is currently at 11% of the public float, but you can expect that grow -- JCP's is at 44%.