Dillard's - An Unappreciated Opportunity

| About: Dillard's Inc. (DDS)


Positive Comparable Store Sales.

Strong EBITDA Growth Over The Past Five Years.

Improving Profitability Both On Gross Margin and Expense Control.

Dillard's, Inc. (NYSE:DDS) ranks among the nation's largest fashion apparel, cosmetics and home furnishings retailers with annual sales of nearly $6.7 billion. The Company operates 284 Dillard's locations and 18 clearance centers spanning 29 states plus an Internet store at dillards.com.

Dillard's reports their financials on a February fiscal year:

Summary of the Company's First Quarter Performance

  1. A 2% increase in comparable store sales
  2. Diluted earnings per share of $2.56 versus $2.50
  3. Cash flow from operations of $161.9 million versus $136.9 million
  4. Share repurchase of $65.9 million (0.7 million shares) of Class A Common Stock

Dillard's Chief Executive Officer, William Dillard, II, stated, "We reported record earnings per share of $2.56 compared to $2.50. Our 2% comparable store sales increase marks our 15th consecutive quarter of positive sales. Additionally, we executed $65.9 million of share buyback as a result of our strong cash flow."

The Company reports positive comparable same store sales (comps) trends and strong EBITDA growth over the past five years. Comps have increased for 14 consecutive quarters and have exceeded the industry average for most of this time frame. The Company has also made progress in improving profitability both on gross margin and expense control.

For 2013, Dillard's EBITDA margin of 12% demonstrates that it has significantly narrowed the gap to the strong industry leaders that have EBITDA margins in the 14%-15% range. My expectation is that Dillard's can continue comps growth in the 1%-2% range.

The company still has some problems in the area of productivity. Sales productivity as measured by sales per square foot and operating profitability relative to department store peers remain trouble spots.

As previously stated, comps have shown improvement over the past five years though change has been inconsistent. The improvement has been driven by improving its merchandise assortment towards more upscale brands, better in-store execution, and strong inventory control. The Company has also been closing underperforming stores. Dillard's low sales per square foot performance offers an opportunity for improvement.

Liquidity remains strong and is supported by a cash balance of $312.1 million as of May 3, 2014. The Company has generated approximately $416.4 million in free cash flow for the trailing twelve month period. Assuming modest working capital requirements and slightly higher capex, I expect DDS to continue generating free cash of about $400 million per year. The Company will be in a position to direct excess free cash toward share buybacks and/or increased dividends.

In a previous SA article, I offered the opinion that it was a good investment opportunity. I reiterate that opinion now. At the time, DDS traded for about $79 per share. It currently trades for close to $118 per share.

Dillard's is a profitable company. It has an EBITDA less Capex to Invested Capital ratio of 22%. EBITDA less capex is a loose version of free cash and tells us what type of return we get. The industry median is about 5.1%.

Valuation is a key component in making any investment decision. DDS has a Free Cash Flow to Price ratio of 8%. The industry median is 1.28%. Another valuable metric to determine valuation is Enterprise Value to EBITDA. DDS has a ratio of 7.64X. The industry median is 11.45X.

Cash flow is essential to all businesses. Regardless of whether a company is profitable on an earnings basis or not, it needs cash to pay its bills. Dillard's generates Free Cash to Operating Income at 75.59%. This compares to the industry median of 39.73%. Cash Return on Invested capital can be compared to ROIC. With CFROI, we look for a return based on the free cash generated by the business. DDS has a CFROI of 14.57% whereas the industry median is 8.85%.

Debt is one factor that can always be trusted to interfere with the best laid plans management may dream. Debt is a red flag if the company cannot manage the load. I compare free cash to long term debt. DDS has a free cash to LTD ratio of 0.51. This is an absolute minimum for me and is something to watch very closely. It is little comfort to me that the industry median is 0.06.

Finally, I look at market sentiment as measured by the 52 week price range. Dillard's is trading near its 52 week high. Absent the unexpected, price momentum should compel the share price higher. Over the past 52 weeks, Dillard's share price has appreciated about 44%. I think that Dillard's share price can appreciate by another 33%.

Disclosure: The author is long DDS. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.