Reitmans Is Very Cheap

| About: Reitmans (Canada) (RTMAF)
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As Reitmans (OTCPK:RTMAF) has seen declining same-store sales and reduced profitability, shares of the profitable retailer have been battered as of late, now down 50% from their year-ago levels. As a result, the company now trades for less than half of its sales, despite a strong net cash position representing one-third of the company's market cap. Furthermore, Reitmans is run by a management team with a strong track record that has implemented a number of initiatives to return margins to normal.

*Note that the company also trades in Canada under the much more liquid RET.A

The Business

Reitmans is a Canadian retailer of women's apparel, operating 900 stores under a number of banners including Reitmans, RW & Co, and Thyme Maternity. The large number of stores provides scale (e.g. marketing, technology and other costs are spread over a large number of units) while the various banners give the company options in terms of where it is receiving the best returns on capital.

This model has served Reitmans well, as seen by the company's returns on equity over the last decade:

Recent Problems

Also obvious from the above chart is that Reitmans' returns have come under pressure as of late. The company recently botched the roll-out of a new warehouse management system, which caused "serious disruption in the flow of inventory to stores." The company estimates the negative impact of this disruption at up to $15 million of EBITDA (the company earned $30 million in its most recent fiscal year).

Initiatives To Return Margins

Though shareholders don't like to see management make such egregious errors, it is worth pointing out that this is a fixable, rather than a permanent problem. Indeed, management claims "the company has addressed the issues related to the warehouse management system and continues to improve the flow of goods to the stores and optimize system performance."

Management is also undertaking a range of other actions to return margins to historical levels. The company has embarked on a rebranding campaign for some of its more troubled banners. This is a work in progress, with management recently commenting that it remains "hopeful for its success."

Reitmans is also expanding sales by growing a wholesale business in addition to its retail business. The company is beginning or is in the growth stage of selling its maternity wear into the US through Babies"R"Us, its Addition Elle line into Australia and New Zealand through EziBuy, and its plus-size apparel into Sears.

The company is also growing its sales through e-commerce, having recently launched all of its banners (as of July 2013) under this direct fulfillment channel, through its existing distribution centre.

Finally, Reitmans is also cutting costs. Capex is expected to come in at $44 million this year, which is $20 million less than the current year's depreciation. Headcount has been reduced, and "process improvements are anticipated to result in additional savings and further improve efficiencies." The company's store count has also been shrinking as it allows leases in its least profitable stores to expire.

As evidence that the company may be putting its problems behind it, Reitmans recently announced that same-store sales for August were 3% higher than they were at the same time last year.

Management

Jeremy Reitman has been the chairman and chief executive at Reitmans since 1975. John Morris, the analyst following the company for BMO Nesbitt Burns says of Reitmans: "This is one of the best management teams in retail, in our opinion."

Management and directors own almost $80 million worth of the company's shares, so their incentives do appear aligned with those of shareholders.

Valuation

Reitmans has generated operating margins in the double-digits for much of this decade. However, through the initiatives described above, even if management were only able to return margins to 7% of sales rather to 10% or above, the stock would currently have an ex-cash P/E of just 6. If the stock were accorded a more reasonable multiple of just 10, which is much less than the current market average, the stock would have upside of 67% from the current level.

Downside risk appears minimal, as the company's free cash flow is positive thanks to management's reduced capital spend. The company's massive cash position gives the company plenty of time to fix the problems that are afflicting it.

Risks

Should things continue to get worse, good luck ousting management. The company's shares operate under a dual-class structure, with insiders controlling the company's voting shares. The bet here is squarely on management, not on some strategic or financial buyer coming to the defense of other shareholders.

Also, the competitive environment in Canada may be heating up. Consumer debt levels have continued their unrelenting ascent, resulting in a fragile consumer, but also one which has attracted American retailers to expand north where demand has been relatively strong. The increased competition from retailers such as Target has likely hurt Reitmans, which must continue to adapt just to retain its market position. Once again, the company's large cash position serves as a defense to any near-term issues caused by oversupply.

It's also worth noting that the company's dividend payout ratio is currently over 100%. As a result, the company's dividend yield is almost 12%, but at risk of being cut. This is usually not good news for a stock in the short-term, but for long-term investors, any cut may be a positive, as it would give the company more time to sort through its issues.

Conclusion

Reitmans appears to offer asymmetric returns to the long-term investor. Temporary problems have caused a massive reduction in the share price, though the company's advantages, including its scale and management, remain largely in place. The company's net cash balance, which is one-third of the company's market cap, ensures management has the time it needs to get the company back on track.

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.

Additional disclosure: I am long RET.A