Cato Corporation (NYSE:CATO) reported third-quarter earnings Thursday, with earnings per share of 16 cents coming in at the high side of the company's guidance (for 12 to 17 cents per share). The market seems relatively content with the earnings release; as of this writing, the stock has fallen less than 1% on a down day in the broad market. Cato also slightly improved its full-year guidance, raising and narrowing its range from $2.18-$2.27 per share to $2.22-$2.26.
The bump up in guidance may have been priced in, as Cato has historically underpromised and overdelivered with its initial full-year projections. But that guidance does promise at least minimal earnings growth for Cato, as 2011 EPS came in at $2.21 a year ago. The guidance also reaffirms Cato's seemingly low valuation; at its 12 p.m. ET trading price of $27.51, the stock trades for just 12.3 times the midpoint of 2012 guidance, and just 8.3 times its forward earnings when backing out its nearly $9 per share in cash.
That's the good news. The problem for Cato is that its earnings growth rate has slowed significantly. Looking at key figures for the company, it's not hard to see why:
|Year||Earnings Per Share||Same Store Sales||Net Store Openings|
* = midpoint of company guidance for $2.22-$2.26
** = year to date
Cato has, over the last few years, managed to better than double its net income. However, revenue for the trailing 12 months is $923.3 million, barely 10% better than 2007's full-year figure of $834.3 million. The company is not creating comp growth, nor is it adding substantial new store locations. Cato had expected to open 45 new stores and close 13 locations in 2012, according to guidance given in conjunction with Q4 2011 earnings. So far, openings have totaled just 25, with closings at seven, leaving the company well behind schedule for the year.
Cato management deserves credit for controlling costs and limiting markdowns amid what CEO John Cato has repeatedly called a "difficult" retail environment. But today's earnings report shows the limit of the company's ability to cut its way to bottom-line growth. Q3 sales were up just 2%, same-store sales fell 2%, gross margin fell 12 basis points, and earnings fell 24%. Year to date, comps remain down, as noted above, and net revenue is up less than half a percent. In fact, the modest growth projected for full-year earnings is mostly accounted for by the fact that Cato's fiscal 2012 has 53 weeks as opposed to 52 weeks the year before.
With many of Cato's retail locations situated in the still-struggling Southeast, and most of its customers among the economically squeezed middle class, it's going to be difficult for the company to grow its top line barring a massive expansion, something the company appears uninterested in. That will leave it susceptible to inflationary pressures such as supplier and labor costs. Even a small shock -- such as a spike in gasoline prices -- could be enough to wipe out Cato's top- and bottom-line growth going forward.
The company's poor growth profile likely explains its admittedly cheap valuation. At $27.51 per share, with a dividend yield over 3.6%, Cato is hardly overpriced. But it's not yet a solid value play either. A little over a year ago, I argued forcefully for a buy of CATO at $22.56. I don't think it needs to drop that far again. At, say, $25 per share with $9 per share in cash, a 4% dividend yield, and lower volatility than most of its peers, CATO is worth a look. But right now, behind the sterling numbers, there is substantial earnings risk that is not quite priced in.