Wednesday, September 9, 2009

Et tu, Cato?

The last company on my retail screen is Cato Corp (CTR). One online profile describes CTR this way:
The Cato Corporation, founded in 1946, operated 1,244 women's fashion specialty stores at January 28, 2006, in 31 states, principally in the southeastern United States, under the names Cato, Cato Fashions, Cato Plus and It's Fashion!. The Company offers quality fashion apparel and accessories at low prices, every day in junior/missy and plus sizes. Additionally, the Company offers clothing for girls sizes 7 to 16 in selected locations. The Company's stores feature a assortment of apparel and accessories, including dressy, career, and casual sportswear, dresses, coats, shoes, lingerie, costume jewelry and handbags. A major portion of the Company's merchandise is sold under its private label and is produced by various vendors in accordance with the Company's specifications. Most stores range in size from 3,500 to 6,000 square feet and are located primarily in strip shopping centers anchored by national discounters or market-dominant grocery stores. The Company emphasizes friendly customer service and coordinated merchandise presentations in an appealing store environment.
True. The Cato's store I visited was exactly as described. In a strip mall, next to a Payless Shoes. The staff was friendly. The store: bright and cheerful.

I was the only male in attendance, but I'm getting used to quizzical looks. When approached, I told Sandy that I was just looking. She smiled and told me if I needed any help to just ask. So I did. I told her why I was there and asked about the company and the store. She offered several insights. When I asked about the number of customers, she replied, "Oh, we're like this all the time... just steady." Headquarters can be proud.

On a random afternoon in the middle of a week, Cato was steady indeed. Very affordable clothing and a range of sizes covering a range of fashion choices and needs. In short... value.
I was very impressed, but I know absolutely nothing about fashion, women's or otherwise.

But Cato does.

The company hasn't had an unprofitable year as far back as I can find data. Profit is "steady" between $30 million and $50 million every year. If you're looking for torrid growth, go someplace else. If you want to make money, buy some Cato!

But let's take a step back. When I first looked at Cato, the company had the following stats.

27.8 million A shares outstanding
1.75 million B shares outstanding (more on this later)
for a total of 29.5 million shares trading around $17 a share
That's a market capitalization of roughly $500 million.

So based on the profitability figures above, Cato is fairly valued with a P/E multiple of 10 - 15 times, right? I almost made that mistake myself.

I didn't key in on Cato because of any fashion or retail insights. It was the balance sheet. And, oh, what a balance sheet! Many of you know my penchant for pretty balance sheets. This one had me positively weeping with joy.

As of August 1, CTR had $174.3 million in cash (35% of its market cap) and ZERO debt. I simpler balance sheet will be hard to find. Just 14 lines long.

Cato's adjusted market value is (or was) just $326 million. On a P/E basis, CTR is trading somewhere between 6.5x and 11x. And I think this retail environment plays to the company's strengths. The company pays out almost $20 million a year in dividends, which works out to a near 4% dividend.

One caution about Cato. It is a corporate governance nightmare. Two classes of stock and an incestuous board. Oops, did I say that out loud? Mr. Cato is paid way too much. He already owns a large equity stake and the supervoting B shares give him 39% of the voting rights. I think he is taking advantage. Ironically, like all such cases, this only costs him money in the long run because many shareholders stay away.

To me, these are issues that can change. Mr. Cato does NOT control a majority of the company. His board can be improved. And the dual share structure can be changed. It would be beneficial to all involved. Incentives, Mr. Cato... always focus on incentives.

CTR should look at J&J Snack Foods (JJSF). This is another family-controlled firm. The CEO/founder is also overpaid, but the company has a better board and one class of shares. JJSF also has a net cash position, but the valuation at this point is crazy. The difference in valuations can't be explained by this alone, but it doesn't hurt. Being "unfriendly" to shareholders ultimately costs you money, Mr. Cato! And it's a sign of insecurity.

Knowing all of Cato's warts, I bought some at an average cost of less than $17 a share. In less than 2 weeks, the shares have risen to $18.45. The balance sheet and consistent profitability were enough for me, but Mr. Cato has the power to make CTR a real winner. If he doesn't act, some outside group may take the initiative to fight for change.

I'm getting paid to wait!

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