Hefty Markup on Dillard's

In spite of a bleak outlook for consumer spending, many retailers have seen their stocks explode upward in recent months. Some of this can be attributed to a reversal of the excessive pessimism around the March lows in the market, but the price action in recent weeks suggests that some investors (who may have missed the rally) are indiscriminately getting into the market and that heavily shorted stocks are rising due to short covering. A stock that exemplifies this is Dillard’s Inc. (DDS), which is a regional apparel and home furnishing retailer.

Declining sales and lacklustre earnings

Dillard’s did not need a major recession to experience declining sales. In fact, sales contracted more than 10% between 2000 and 2007. Since then, the decline has accelerated. Sales were down 5.5% in fiscal year 2008 and down 16% in the quarter ended May 2, 2009 (same store sales were down 13%). The most recent data is sales for July, during which Dillard’s sales declined 15% compared to July last year (same store sales declined 12%).

The story isn’t any better if we look at the earnings. In the last ten years, Dillard’s cumulative earnings per share amount to a measly $1.16, or less than 12 cents per share in an average year.

Rigor mortis

The one positive point is that Dillard’s managed to have positive net income ($0.10) per share in the most recent quarter, which is an impressive turnaround, given the ongoing sales decline and considering that the loss for 2008 was $3.25 per share. This was achieved through cost cuts and by drastically reducing inventory. While management should get credit for doing what it can in a difficult environment, the outlook for Dillard’s in coming years seems to indicate further sales contraction. Considering the fundamental change that consumer spending is undergoing and the lack of differentiation Dillard’s has from its competitors, it is hard to see how the next ten years will be better than the last ten.

At first glance, Dillard’s seems cheap by one measure: Price/Book, which currently is around 0.4. However, realizing this book value will not be easy. Most of Dillard’s assets consist of inventory (29%) and the stores themselves (property and equipment accounts for 63% of assets). Most of Dillard´s stores are located in suburban shopping malls. The decline of shopping malls is well documented. It is hard to imagine Dillard’s assets being realized near book value anytime soon.

Source of financial statement information: Gridstone Research.

Disclosure: Short DDS call options at time of writing.