Cato Corporation (CATO) reported fiscal first quarter results last week; though earnings and revenue fell year-over-year, the release appeared to be good enough for the market. CATO gained a little over one percent on the day and continued a recent run up from fourteen-month lows reached in mid-April.
At Wednesday's close of $25.07, CATO still looks cheap. The company has guided for fiscal 2013 earnings per share of $1.66-$1.84; at the midpoint of guidance, the stock offers a forward P/E of about 14. Backing out the company's net cash of $8 per share, the P/E drops to single digits.
But as I argued last month, the low valuation masks a series of problems at the retailer. The company's locations are predominantly in the Southeast, a region still hard-hit by the recent recession. In the Q1 release, chairman and CEO John Cato again bemoaned the "continuing difficult economic conditions" facing consumers, while also highlighting the headwinds posed by delayed income tax refunds and cold weather in March and April. In a press release describing highlights from the company's annual meeting (held the same day earnings were released), Cato again focused on the struggles facing his customers, while the release noted that "The Company expects that 2013 will again be very challenging."
Cato had managed to grow earnings despite modest revenue growth, only to see earnings per share decline 5 percent last year. That decline is accelerating, with the company's guidance projecting a drop of 13-21 percent year-over-year. Same-store sales continue to show declines, falling 4 percent last year and another 5 percent in the first quarter. The company reiterated its guidance to open 65 new locations, while closing up to 15; the net addition of 50 stores would increase store count by 4 percent, perhaps offsetting comp declines. But the company actually closed six stores and opened three in Q1, casting doubt on its ability to meet its target. Curiously, Cato has repeatedly over-promised on its guidance for store openings:
data compiled by author from company releases; figures are net of projected/actual store closings
With the company off to a slow start, and its recent history, it would be unsurprising if the target of 65 new locations is once again missed. At the annual meeting, CEO Cato also announced plans for new office space, new distribution facilities, and a new e-commerce program, which it anticipates will go online in Q4. These projects will increase expenses in the near term and may also distract the company from its store expansion plans.
Bulls have pointed to Cato's balance sheet, its valuation, and new concepts Versona Accessories and It's Fashions as potential catalysts for a share price rebound. But this is a company who is losing investor confidence. The constant finger-pointing at an admittedly tepid economic recovery is getting old. Retailers across the country and across segments have massively outperformed the broad market over the last five years, with most of those stores serving customer bases with the same issues as Cato customers. They have adapted by creating new concepts, managing costs, and/or expanding locations. Cato has done things; but not well as of late, and certainly not as promised. Earnings guidance was missed in 2012, and in Q1 of this year; store openings guidance has been missed for years, seemingly without acknowledgement from the company. The Versona concept has shown promise, but with only 26 locations and 15 more planned for 2013, it is not nearly ready to be an earnings driver.
So, yes, CATO stock looks cheap; but earnings are declining and there is no real plan from Cato itself as to how the company plans to reverse that decline. New distribution facilities are nice, and an e-commerce platform could drive incremental revenues. But with comps falling 4-5 percent, and a failure to add significant additional square footage, revenue growth is going to be modest, at best, and earnings growth will be difficult to maintain. Cato looks and sounds directionless right now; and as the company goes, so will its stock price.