Thursday, May 19, 2011

Cato Catches a Bid

The value retail market is dead.  So say many analysts and their fans in the financial press.  The rationale is obvious, they say.  Thanks to high unemployment, only retailers catering to the upper middles to the upper uppers are doing well.  This means Nordstrom (JWN), Saks (SKS), and even Macy's (M).

Apparently, you poor saps who collect a paycheck don't buy clothes during tough economic times!

Money managers love to own the "elite" retailers.  After all, they are well-known companies with cache.  You can talk about these at the cocktail party without embarrassment. Nonetheless, for those willing to lower themselves, the value arena is not devoid of opportunity.

Witness today's report from Cato Corp (CATO).  Now I know that many of you get queasy if you've never heard of a company, but please hang in there.  Cato is a value-priced women's retailer that is clearly providing women a product they want at a price they can afford.  This is the only explanation for the company's serial successes in recent years.  The most recent quarter was a record, with sales up 5% and earnings up 22%. 

Cato's market value is just less than $800 million (29.5 million shares @ 26.80 a share). The company's 2011 earnings guidance is now $2.11 to $2.19 a share.  So why get excited about $62 million in projected earnings?  A multiple of 12 to 13x earnings?

For one, there is the fact that Cato is putting up these numbers in a very difficult environment.  Just imagine what they'll accomplish if/when employment picks up?!   But if you lack imagination (like me) and still are not convinced, please take moment to look at Cato's balance sheet.

As of April 30th, Cato shows $261 million in unrestricted cash on hand (and no debt).  That's $8.85 a share.  Or 35% of the company's market value.  Adjusted for this cash, Cato trades at just 8.5x earnings.  You could say that Cato is risk averse, but their cash hoard is not due to a lack of dividends.  The company pays an 18.5 cent quarterly dividend, a yield of 2.75%.

A cash rich retailer trading at a single-digit multiple that is growing in a difficult marketplace?  Say it ain't so!

Call me a fan of the company (especially at this price).

That said, there are caveats.  I am less than excited by the company's dual share class structure and Mr. Cato's $3+ million compensation package.  Apparently owning 2 million shares isn't enough.  But by owning (only) 7% of the outstanding shares, our company's leader controls 40% of the voting rights.  Seems fair to me!?!!  Or not.

Clearly, someone wants the benefit of a private company, while still being public.  Let them eat cake!  It is a shame, but this is typical of those who have the votes to set their own pay.  It is also the hallmark of a weak board of directors.

Nonetheless, despite the current valuation, it is unlikely that Mr. Cato is going to realize that his super-voting shares are part of the problem.  (Note to Mr. Cato:  They are!)  

More realistically, I'd like to see a lower cash hoard and higher dividends.  On this front there is hope... if only owing to the self-interest of Mr. Cato.  Cato's "board of directors" will be meeting on May 24.  Look for a dividend increase.

In discussions with the company, I have suggested a self-tender offer and/or a large special dividend, but don't hold your breath.  There is only one shareholder whose opinion matters, regardless of how short-sighted it may be.

So here's hoping the board members come to their senses, because the value is there to be unlocked.
Nonetheless, if the board doesn't return a significant amount of cash to shareholders (including those of us not named Cato), then Cato's conversion into a glorified savings account will continue.  If this is the case, ignore all the superlatives above.  And sell.

Cato is a good business, but if corporate governance does not improve, the discount to fair value may be permanent.  Nobody wants to partner with managers whose disdain for outside shareholders is on full display.

Disclosure: Long CATO... for now.


  1. Not sure if you're looking for an undervalued company or just a retailer that is growing in today's "very difficult environment", but I think this is a better purchase:

    Aeropostale is running into a few small problems but they're much cheaper today. I think worth a serious look.

    As always your posts are interesting- thanks for sharing.

  2. schneck,

    Let me start by making you feel better... I own ARO too. It doesn't have to be an either or proposition.

    But either way, I'm not sure about the notion that ARO is cheaper... actually I am... and I don't think it is cheaper. No dividend... a lousy quarter, etc.

    So now I'm wondering... why do I own ARO. Cato is cheaper, with more catalysts, paying a bigger dividend, smaller... Cato has a better balance sheet, etc.

    I am looking for an undervalued company. And Cato is doing well in this environment (unlike ARO) which makes its valuation a mystery. Whereas given recent performance, ARO's valuation starts to make more sense.

    But yes, I still own both.