6 Retailers: An Evaluation Of Growth + Income

by: Andrew Boral

In this article, six retailers are examined. Each of the retailers is reasonably liquid and, given their track records, trade for acceptable multiples of earnings. Each of the stocks has appreciation potential. Yet investors seeking income in addition to growth may want to avoid Bed Bath & Beyond (NASDAQ:BBBY) and Dollar Tree (NASDAQ:DLTR) as these stocks do not pay a dividend. Williams-Sonoma (NYSE:WSM) pays the highest dividend of the retailers while also having the highest dividend payout ratio. As this article examines each of these companies in detail, the Williams-Sonoma dividend seems sustainable given the level of capital expenditures.

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Stock Statistics

The table below gives some summary valuation statistics. It is clear that Williams-Sonoma is the smallest company by market capitalization. The next largest, Family Dollar Stores (NYSE:FDO), received a buyout offer for $7 billion. Unfortunately this transaction has not materialized. That would have provided a nice premium to its current valuation. When comparing other statistics, the price-to-earnings multiple are ranging from a low of 13.5 to a high of 23.1. Williams-Sonoma and Bed Bath & Beyond are situated in the middle of the distribution, with price-to-earnings multiples of 16.2 and 17.3, respectively. However, in terms of the price-to-book ratio, Bed Bath & Beyond is near the top of the range. Williams-Sonoma has a more reasonable price-to-book ratio, which is 1.6 times lower.

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valuation statistics

Leverage Ratios

While all of these retailers have low debt levels, two companies have outstanding debt levels on their balance sheet. Bed Bath & Beyond and Williams-Sonoma have zero or near zero debt on their balance sheets. This gives both of these companies very strong financial strength as low debt levels are extremely healthy. This capital position will allow the companies to be more flexibility during difficult times. The low debt levels are also remarkable given that the United States has recently exited a recessionary period. In the macroeconomic picture, consumers have begun to save more. Yet Bed Bath & Beyond and Williams-Sonoma were able to sustain their businesses without external financing.

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Leverage Ratios

Inventory and Profitability Ratios

A quick comparison of the inventory ratios shows that these retailers cater to very different markets. On one end of the spectrum is Costco (NASDAQ:COST), which has the highest inventory turnover. Costco replaces its inventory in a little under a month. On the other end of the scale is Bed Bath & Beyond. This company takes almost four months to turn over its inventory. Having a high inventory turnover and a low number of days of goods in inventory is typically a good sign for a retailer. In addition, Costco does not have high inventories as a percentage of its sales. This type of retailing is closer to the just-in-time inventory method pioneered by the Japanese automobile manufacturers at the end of the last century.

Why are companies able to compete with lower inventory turnover numbers? It generally has to do with higher profitability measures on the products that are sold. Costco’s profit margins are the lowest in the group. In particular, Bed Bath & Beyond has been able to manage its SG&A expenses leaving the company with the highest profit margins of the group. Costco competes on volume of goods sold. Costco stores need a tremendous amount of traffic to remain profitable. In contrast, Bed Bath & Beyond and Williams-Sonoma have the two highest gross margins. In particular, Williams-Sonoma has many exclusive relationships with high-end culinary manufacturers allowing it to charge premium prices. Williams-Sonoma also maintains a significant online presence which has low overhead expenses. Williams-Sonoma and Bed Bath & Beyond carry high quality products. These retailers provide good quality customer service and in general have more amenities than a retailer such as Costco. When considering Costco, as gas prices decline and membership prices have increased, it is unlikely that Costco will be able to improve margins. Since they already have the lowest margins and highest volumes in this grouping, the traffic dynamics will be difficult to improve. The most likely avenue for growth is through further increasing in store traffic. This will not be likely to be easy to achieve.

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Inventory Ratios

Profitability Ratios

Bed Bath & Beyond and Williams-Sonoma seem well able to finance their capital expenditures from free cash flow. Each of these companies has a multiple of free cash flow compared to their capital expenditures. Their businesses are generating enough excess to finance expansion and maintenance plans. In contrast Family Dollar is aggressively investing in expansion. Perhaps this is too aggressive and cannot be internally funded. Dollar Tree is also seeking to expand the number of stores. However it is in a better financial position to increase in size.

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Both Bed Bath & Beyond and Williams-Sonoma compare favorably to each of the other three companies in this study. Dollar Tree has also done well historically. Value Line's most recent ranking of each of these six equities for timeliness is either a 2 or a 3. In particular, Bed Bath & Beyond is ranked 3 for timeliness and Williams-Sonoma and Dollar Tree are ranked 2 for timeliness. Regardless of the rankings, it is apparent that Bed Bath & Beyond is able to produce higher margins at each level, gross margin, operating margin, and profit margin. It is also true that Williams-Sonoma is able to maintain high margins as well. However, Bed Bath & Beyond does dominate in this area. Dollar Tree is planning to grow by significantly increasing the number of its stores. In contrast with Bed Bath & Beyond and Dollar Tree is Williams-Sonoma's dividend. It pays the highest yield of 1.67% of the group and given its healthy free cash flow, is likely able to maintain this dividend. This may be a good incentive for conservative investors waiting for growth in these equities. Bed Bath & Beyond and Dollar Tree do not provide an income to conservative investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: The statistical information for this article comes directly from SEC filings through Edgar Online for the most recent time period. Timeliness ratings were taken from the most recent publication of Value Lines Investment Survey.