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When one thinks of small-cap stocks, he may think of extreme volatility in earnings and many other risks that may come with buying the company. But Rue21 (RUE), a small-cap apparel company, is very much different from this normal description. Having many merits which make up for these flaws, the stock looks like it can grow further over the next few years and possibly become a favorable investment over the long term.

Introduction

Rue21, Inc. operates as a specialty apparel retailer in the United States. It provides fashion apparel and accessories for girls and guys, including graphic T-shirts, denim, dresses, shirts, hoodies, belts, jewelry, handbags, footwear, intimate apparel, and other accessories. As of August 23, 2012, it operated 843 stores in 46 states.

One thing I like about Rue21's business is its simplicity, unlike some companies, whose business overview is difficult to understand.

Snapshot:

Price (13.11.2012)$28.31
Market Cap673.5M
Income (2011)42.35M (P/E: 16.75)
Sales (2011)822.33M (P/S: 0.82)
Book Value Per Share (BVPS)$6.66 (P/B: 4.25)
Return On Equity (ROE)29.92%
Debt/Equity Ratio0.00 (No Debt)
EPS Growth Past 5 Years34.27%
Current Ratio1.53

Here are a few of its merits:

1. Good Value

Firstly, it is priced at a really reasonable 16.75X earnings, which is considerably lower than its average P/E number since its November 2009 IPO, which is 21.54. The table below shows its P/E values from April 2010 onwards. (Note that its lowest P/E value was 14.20, in August 2012, which is also not far from today's 16.75.)

MonthP/E Ratio
April 201029.81
October 201023.77
April 201122.15
October 201118.12
April 201218.62
November 201216.75
Average21.54

Rue21's Price/Book and Price/Sales values are also acceptable numbers, at 4.25 and 0.82 respectively. This is in line with most of its competitors, like Ross Stores (ROST), with a P/B of 7.43 and a P/S of 1.35; or Nordstrom (JWN), with a P/B of 6.00 and a P/S of 0.94.

2. Impressive EPS Growth

I am also impressed with Rue21's rapidly growing EPS number, and in fact, if you refer to the table below, this number has grown every year since 2004 (before IPO).

YearEPS ($)Growth
20040.18-
20050.3383.3%
20060.369.1%
20070.4011.1%
20080.5537.5%
20090.9674.5%
20101.2126.0%
20111.5528.1%

I believe that Rue21's earnings will continue to grow at this rate as more people turn to discount or off price retailers, given the economic conditions now. With unemployment very high and with growth slowing, people will try to scrimp and save for times of hardship, and therefore turn to off price retailers like Rue21 and larger competitor Ross Stores. This is one potential catalyst to push earnings higher in the future.

The 79 stores we opened in the first half of 2012 are even more profitable than in any prior years with record performance in terms of both sales and profits.

Additionally, the company plans to further increase the number of stores they have. In fact, they plan to increase the number of stores by 41 for the rest of 2012. I believe that they will continue to grow their stores at a similar rate as they had been very well-received in the stores that they had recently opened, as shown in the excerpt from its 2012 Q2 conference call held in August. This includes Long Island - they plan to open another 8-10 stores there after a very well-received first store.

3. Growing BVPS

Thirdly, I also like their book value per share (BVPS) growth over the past few years. This number had grown very quickly so far but its growth is bound to slow down as the company increases in size. But I still expect it to still grow very consistently in the coming years. The BVPS value is determined by relating the original value of a firm's common stock adjusted for any outflow (dividends and stock buybacks) and inflow (retained earnings).

Book Value Per Share 2008$0.26
Book Value Per Share 2009$0.82
Book Value Per Share 2010$2.78
Book Value Per Share 2011$4.20
Book Value Per Share 2012$6.02
Book Value Per Share Latest Quarter$6.66

4. No Debt

Fourthly, it has no debt of any sort. It has maintained this position of zero debt since 2010. Additionally, over the past 8 years, its total debt had not increased above 28M, which is remarkable. This means that Rue21 is earning enough and does not need to consistently rely on debt to expand itself. Below shows a table containing Rue21's debt figures.

YearDebt ($)
20040
20050
20060
200727.97M
200819.48M
20090
20100
20110

5. High ROE number

Additionally, Rue21's return on equity (ROE) number had been maintained at a very high rate since its IPO, locking in an impressive 29.92%. A high ROE indicates that a company's management is using shareholders' money more effectively, which is good both for the company and its shareholders. The definition of ROE is the amount of net income returned as a percentage of shareholders' investments. This measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.

6. Management Plans To Buy Back Shares

Lastly, even though Rue shares had been diluted since its IPO, with shares outstanding increasing from 21.87M during its IPO to 24.48M today, this dilution rate had slowed considerably recently, and management is planning to start buying back shares, as shown in the excerpt below from its Q2 2012 conference call held in August. This is beneficial to shareholders as shareholders do not own the whole company - they only own part of the company. Share buybacks will enable shareholders to own a larger part of the company without owning more shares.

This is also a positive sign that the company is starting to be able to earn more than what it needs to expand and perform its internal operations, that now it is starting to return to shareholders.

A strong predictable cash flow is the primary reason our board approved the repurchase of Rue shares up to $50 million. We look forward to continue to create shareholder value through our buyback program as we move through 2012 and beyond.

7. Strong Balance Sheet

Before I start on anything, here is Rue21's balance sheet on Yahoo Finance.

Firstly, Rue21's cash and cash equivalents had increased from 26.75M in the year ended January 29th, 2010 to 41.96M in the year ended January 27th, 2012. This represents a 57% increase in cash, which is impressive considering that it was only over 3 years.

Secondly, Rue21's assets grew faster than its liabilities over the past three years. From the year ended January 29th, 2010, to the year ended January 27th, 2012, total assets had increased from $188.4M to $348.0M, an increase of 84.7% over three years. On the other hand, its total liabilities had increased from $121.0M to $200.8M, an increase of only 65.9% over the past three years.

Thirdly, Rue21 has more current assets than current liabilities. As of January 29th, 2012, it had $229.2M in current assets and $142.2M in current liabilities. This is a good sign as the company is able to pay off its short-term liabilities if it is obliged to pay all of them off at one time, especially after considering that most of Rue21's liabilities are made up of accounts payable.

Lastly, Rue21 has no preferred stock, which is a good sign for the company and its shareholders -- it does not need to pay extra special dividends, which would only drain its cash reserves faster. A company that has preferred stock also shows how cash-strapped it is to have to borrow money from its shareholders, technically, at higher interests than normal (special dividends, etc.).

8. High Short Float

This may not be a merit for some but it sure is one to me. A stock with a high short float could go through a short squeeze if the company performs well in short term events like quarterly earnings or other such reports. Rue21 has a 13.37% short float and this could be a perfect catalyst to push stock prices higher.

Key Risks/Flaws

Every company, regardless of how perfect it seems, is bound to have some flaws. Here, I will list some of Rue21's key risks and flaws.

Firstly, Rue21's days inventory number has been increasing over the past few years, from 94.60 in 2008 to 120 as of the latest quarter. This means goods are staying in the inventory for a longer amount of time, which is not good at all. Days inventory is a measure of a company's performance that gives investors an idea of how long it takes the company to sell its goods in the inventory. This could be a sign that there is less demand. The chart below shows the days inventory numbers for Rue21 from 2008 onwards.

Days Inventory 200894.6
Days Inventory 200978.6
Days Inventory 201087.7
Days Inventory 2011101
Days Inventory Latest Quarter120

Secondly, Rue21's profit margins are lower than that of some competitors. It has a low 5.15% profit margin, which already is bad by itself. Additionally, compared to other similar-sized competitors like Joseph A. Bank Clothiers (JOSB) with a 9.54% profit margin, or Guess? Inc. (GES) with a 8.94% profit margin, this number looks even worse. The definition of profit margin is how much out of every dollar of sales a company keeps in earnings. This is a sign that Rue21 spends quite a large amount of its revenue for other uses and that Rue21 may need to control its costs better.

The Takeaway

Rue21 may just be a small cap stock, but it seems to be poised for further long-term growth after showing a whole host of qualities. Although it also has some flaws, like any other company has, its merits make up for all these flaws and make the company a favorable long term investment.

Source: Rue21: Gearing Up For Further Long-Term Growth