Wednesday, December 2, 2009

Retail Tunnel Vision

Sir John Templeton counseled would-be value investors to invest at the point of maximum pessimism. It's safe to say he'd be skeptical of Apple, Google, and Amazon, especially at current prices. But we're told these are great companies, worthy of purchase at almost any price.

I always thought greatness was a title earned over more than 10 years?

Nonetheless, the investment community (and financial press) has created its own version of the Nifty Fifty, the lucky few that garner constant attention. Interestingly, the anointed ones are often technology related and frequently "virtual" (the "nirvana" of business models). All the easier to build pie-in-the-sky valuations.

Despite massive piles of data streaming from public companies, real research seems to be scarce. Aggregate numbers are irrelevant compared to expected growth rates and consensus earnings expectations. Beat "the numbers" and you're golden... miss them and you're a goat.

Not being in the cool crowd is just one of the sins committed by the following retailers. That said, the aggregate numbers look good. Not that anyone's noticed.

Cato Corp (CATO) describes itself as follows:
The Company, founded in 1946, operates over 1,300 women's apparel specialty stores in 31 states under the names "Cato" and "It's Fashion". The Company offers quality fashion apparel and accessories at everyday low prices in junior, missy and plus sizes, as well as girls sizes 7-16. A substantial portion of the Company's merchandise is sold under its private labels and is produced by various vendors in accordance with the Company's specifications. Most stores range in size from 3,000 to 6,000 square feet and are located primarily in strip shopping centers anchored by national discount stores.
The retailer has 29 million shares outstanding (27 million A shares and 1.75 million supervoting B shares). This puts the company's market value at $570 million. They earned $16 million in the most recent quarter bringing the 9 month total to $38 million. On an annualized basis, Cato is trading at around 10x earnings. Not bad, but not exactly a steal.

The attraction to Cato is its little-known balance sheet. As of the most recent earnings release, Cato held $180 million in cash and equivalents, representing over 30% of its market value. The company has ZERO debt. The current dividend is 66 cents per year, a 3.5% current yield.

Adjusting for the cash, Cato trades at a very cheap single digit multiple to both earnings and free cash flow.

Fair warning: Cato is not a poster child for good governance. First, the dual class structure. John Cato owns approximately 6.5% of the actual equity in Cato, but he enjoys a 39% share of all voting rights thanks to the B shares. Mr. Cato's compensation is also a concern. Over the last 3 years it totals $6,641,416. For such a small company, that's ridiculous. One has to question the board.

Another interesting tidbit... according to the most recent proxy letter:
Mr. Cato has pledged 1,740,525 of the Class B Stock to Branch Banking & Trust as collateral under a loan agreement.
So while Cato (the company) is dramatically unleveraged, it appears Cato (the man) isn't. The 1.74 million shares pledged to BB&T represents all but 3,000 of the Class B supervoting shares outstanding and 92% of Mr. Cato's equity in the company.

Despite its warts (or perhaps because of them), Cato is worth a look.

The other beaten down retailer is Hot Topic (HOTT). The company operates over 600 teen retail stores focusing on music, "rock-inspired apparel", and the underground cartoon, cult movie, and comic book scenes.

Not exactly normal value investor fare to be sure. And this target market has been particularly hard hit by this economy. Indeed, lousy November same store sales and a weak retail environment have driven HOTT shares to fresh 52-week lows. None of this is "new" news.

At current levels, however, it's time to look beyond the headlines. Even Templeton may have gotten hip to HOTT.

With 44 million shares outstanding, Hot Topic has a $242 million market value ($5.50 per share). The company boasts $91 million cash and no debt. And despite the negative news, Hot Topic is profitable (and has been for years). With nearly 40% of its market value in cash, Hot Topic isn't going anywhere. Here's hoping management uses some of this cash to reward shareholders via a dividend or share repurchase. In any case, the doom and gloom is premature.

Clearly, these are not "feel good" stocks. Don't expect validation from Wall Street analysts. No high-fives from your friends at the gym. Just lonely silence. Then again most great investments don't come with a choir of angels. Just ask Buffett about his Geico purchase.

It pays to venture beyond the informal "approved" list.

Disclosure: Long CATO and HOTT. Short AMZN.

1 comment:

  1. hmmm you might want to look at WTSLA as well, similar situation but trading at lower EV than HOTT