Cato Corporation: This Specialty Apparel Retailer A Solid Investment Option

| About: The Cato (CATO)

The Cato Corporation (NYSE:CATO) is a U.S. based holding company and specialty retailer of varied fashion apparel and accessories. Although the company offers selected men, children and babies' apparel and accessories, it is mostly focused on women's apparel. With approximately 1,309 branded retail stores in 32 states, under brand names that include Cato, Cato Fashion, Cato Plus, Its Fashion Metro, Its Fashion and Versona Accessories, the company reported sales of $933.8 million in fiscal year 2012.

Although the industry it operates in is not seeing the best of times now, I still believe that CATO makes a solid investment option for investors who want a play for the long term. More so, CATO pays a healthy dividend and also engages in share repurchases. In 2012 alone, it returned over $87 million to shareholders. In order to increase its net income for fiscal year 2013, the company has plans to open approximately 65 new stores within the fiscal year. It also plans to close 15 of its existing stores and relocate another 15 stores. With its reputation to offer a wide range of trendy casual and dressy apparels and accessories for women, men, children and babies, CATO has continued to grow its revenue.

CATO's two reportable segments are Retail and Credit. The retail segment covers its entire retail operations since they have the similar characteristics while the credit segment covers the use of the company's own credit card by its customers. With the company's management working toward ensuring that CATO attains and maintains the enviable position of a leading provider in the industry it operates in, the company would not spare any details to differentiate its product offerings and operations from its peers in the industry, mass merchandise discount stores and department stores as well.

About the finances

CATO felt a tinge of this year's volatility in same store sales in its industry. It reported a 5% drop in same-store sales with a 3% drop in total sales for the quarter. It missed revenue estimates by $5.28 million with its reported revenue of $231.72 million. The company however beat EPS estimate by $0.03 with its reported EPS of $0.51.

The softer than expected sales in the first half of the year is attributed mostly to unseasonable weather and the prevailing weak economy. With the ever increasing prices of food and gas and limited job opportunities, consumers are cutting their budgets as they stick to necessities. According to the company's management, minimal improvement is expected in the remaining half of 2013.

This expectation played out in the company's report for the four weeks ended August 31, 2013, which showed a consistency with the present paradigm shift in consumer shopping behavior. CATO reported sales of $59.2 million. This indicates a 5% decline in comparison to $62.1 million reported in the same month of the previous fiscal year. The company also reported a 2% decline in same-store sales in comparison to the previous year's same-store sales for August.

The only growth story the company has in the month of August is the addition of more stores and entering a new state. The company opened its first store in Nevada in the reported month.

Major catalyst currently fueling the company's growth

One good thing CATO has going for it is the company's solid cash balance. With the volatility being experienced in the past two quarters, the company's cash position is such that will enable it continue with its long-term growth strategies with minimal hitches. According to management, the available cash is usually utilized "to internally fund new concepts and store development, meet infrastructure needs and provide additional value to long-term shareholders through dividends and share repurchases."

This is already playing out as the company's CEO revealed during the company's 2013 annual meeting. He stated that the management, in reviewing alternatives to CATO's distribution facilities, "bought just under 300 acres of land that was in bankruptcy in South Carolina, located right over the state line." The property is strategically located close to the company's corporate office in Charlotte, NC. The management was also approved to purchase an adjacent 32 acre property from York County. These infrastructural investments are geared toward ensuring maximum facilities to contain and support the company's impending growth.

Catalysts for further growth

There are several catalysts that will further fuel CATO's growth and it includes the following:

  • E-commerce program: With the success being recorded by its peers in international online sales, there is every reason to believe that in moving with the trend, CATO will significantly increase its revenues and earnings in the near future. This is already playing out because according to the company's CEO and Chairman, John Cato, management has plans to start an E-commerce program that will be operational by the 4th quarter of this current fiscal year. In his own words, "We're approaching it a little differently than others by keeping all functions in-house, including a new photography studio, fulfillment center and call center."
  • Recovering economy: The industry the company operates in is one that is sensitive to the economy and as such, a downturn brings about a decline in sales while an improvement spells happy times for CATO and its peers. Based on this, there is bound to increase in spending and demand for discretionary items as the economy recovers.
  • Projected medium market share concentration: With the prevailing merger and acquisition activities in the industry, the number of apparel retailers will continue to shrink. With this trend, the industry will become concentrated with a few but highly profitable companies, including CATO.
  • Possibility of a buyout: CATO has huge growth prospects. Add this to its solid financial standing and you have a company that makes an attractive acquisition candidate since it is sure to provide both short and long term financial benefits to management and investors. Considering that this is a trend that is currently prevalent in the apparel retail industry, it is a possibility.

Holding up amid stiff competition

CATO has incorporated certain elements into its business strategy in order to stand apart from its peers and competitors. Some of these elements include its pricing structure which has made the company a long-standing low-price leader in the specialty apparel industry.

It also offers on-trend apparel and accessories based on varied demographics. It however pays pay more attention to those out for value-shopping, making sure that its offerings are coordinated in terms of color and product. This way, it is easier for customers to assemble full outfits with little or no stress. The company is also exclusively operating convenient strip shopping centers anchored by market-dominant grocery stores and national discounters. These shopping centers are known to attract a higher number of daily shoppers thereby holding a huge growth opportunity for CATO.

CATO competes with well-known department stores like Macy's Inc. (NYSE:M) and Sears Holdings (NASDAQ:SHLD). Macy's second quarter sales were hurt by consumers' behavior as they turned out to be cautious on the purchase of discretionary items. With the behavior negatively impacting on the company's comp store sales and its online business, Macy's lowered its full year EPS guidance from $3.90-$3.95 to $3.80-$3.90. It currently maintains a forward dividend yield of 2.24% with its stock trading at 13.2x earnings multiples.

With Macy's already entrenched in the online international sales, it means CATO will also be competing with it on that front when it finally starts its e-commerce program. The difference there is that CATO management is using a different approach from Macy's and other companies as all its online functions will be in-house. This includes call center, photography studio and fulfillment center. Based on this, its profit margin will be better than the companies that outsource these functions.

Sears is not fairing better either as the company's falling sales is making it harder to cover costs of operations. This is a negative leverage that has taken its toll on the company's investors as they continue to lose money. For a store that used to be ahead of other known names, its crumbling sales say a lot about where the company might be in the next five years. It even got worse with its release of another dismal quarterly report for second quarter 2013. However, with its recent focus on online international sales, just like Macy's, Sears is slowly making headway.

Another competitor is specialty clothing retailer The Gap Inc. (NYSE:GPS). The company was among those that reported strong second quarter sales which moved the management to raise its outlook for the full year. Gap's August report showed a 2% increase in comp store sales for the month. This was strongly impacted by gains from the company's Gap, Old Navy and Banana Republic brands.

Total sales for the reported month stood at $1.23 billion, a 3% increase in comparison to $1.20 billion reported in the same month of the previous fiscal year.

Risks facing the company

The apparel supply industry is one that has faced an array of risks and variables for quite some time now. Some of the risks that can have an adverse significant impact on CATO's revenues and earnings include the following:

  • Significant increase in cotton prices
  • Increased transportation costs
  • Increased sourcing costs
  • Lingering unfavorable economy

Bottom line

There are lots of reasons why CATO makes a good investment option. For one, it is a well-managed company that maintains a solid balance sheet with a significant part of the company's market cap made up of cash. For several quarters now, it has maintained zero short and long-term debts. CATO has and still remains a profitable company that maintains consistent free cash flows.

Also, apart from the company's merchandise line of apparel and accessories being broad, it has been able to maintain competitive pricing power. With its in-house product development efforts, CATO's merchandising and product development teams have been able to create and outshine the competition in terms of top-notch merchandise for the company's store concepts, both in quality and style.

Finally, with the company's strong financial position, CATO is projected to efficiently fund new concepts in the future while at the same time growing the company in the store front. CATO is a shareholder-friendly company that is dedicated to returning value to the company's investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.