- Niche off-price apparel retailer generating solid same-store sales and EBITDA growth (a rarity in today’s retail climate) trading at an embarrassingly inexpensive 4.0X EBITDA multiple
- Fortress balance sheet overcapitalized with ~33% of market capitalization in cash with zero debt and substantial annual free cash flow generation
- Shares collapsed ~20% for no identifiable reason into Q2 earnings report and have yet to retrace losses despite impressive Q2 numbers and guidance, a rare bright spot in the struggling retail landscape
- Concluded messy but ultimately value creating fight with activist fund whereby activist investor landed a Board seat and already has catalyzed shareholder friendly changes
- Citi Trends (NASDAQ:CTRN) announced a $25M authorization on 04/10/17 and aggressively exhausted the entire program in Q2 17 by retiring 8% of diluted shares outstanding
- CTRN upped its dividend by 33%
- CEO resigned in March 2017
- Compelling value under status quo with even greater NPV under either of two scenarios:
- Represents a very interesting acquisition target with interim CEO (very competent existing COO/CFO) and activist in place
- EC’s proprietary LBO analysis suggests upside to $28 in a go-private transaction
- Becomes consolidator in fragmented sector
- Represents a very interesting acquisition target with interim CEO (very competent existing COO/CFO) and activist in place
- Bloomberg and other data providers overstate CTRN’s enterprise value and therefore also its trading multiples. We believe CTRN trades a full 1.0X below reported
- While Amazon (AMZN) is transforming the retail universe, it will be challenged to capture CTRN’s core customer who often lacks a credit card, secure delivery sites, or interest in e-commerce
- Owns unencumbered real estate in the southeastern United States worth ~12-15% of current enterprise value
- Benefits immensely from potential tax reform, given its ~37% effective tax rate and 100% domestic revenues
For several years, CTRN was viewed as a growth stock and assigned growth multiples ranging 8-12X EBITDA for periods in 2013-2015. Following two years of growing pains and operational fixes, CTRN has returned to growth, yet shares languish with distressed valuation multiples currently ascribed to secularly declining mall-based retailers. Its microcap market capitalization and lack of analyst coverage only contribute to the market’s indifference. We believe CTRN deserves to sit in the off-price department store universe, comprising companies like TJX, ROST, and BURL, a sub-sector outperforming in terms of fundamentals, share price performance, and valuation multiples.
We triangulate a valuation range of ~$27-37 per share, which ascribes zero value to tax reform or CTRN’s owned real estate (worth ~$1.50 per share).
Citi Trends operates 545 off-price, urban apparel stores largely located in the southeastern United States. Unlike struggling mall-based retailers, CTRN stores are located primarily in strip centers and street fronts at the heart of their urban customers’ communities.
By offering brands and fashion 20-70% below mall and specialty stores to large customer base with favorable demographics, CTRN has managed to buck the negative trends in retail. CTRN caters largely to moderate income African American families (a growing population with even faster growing incomes) in their communities as opposed to the mall.
CTRN’s revenues comprise five key categories with nearly 80% of revenues from Accessories, Ladies’, and Children.
CTRN sources flexibly from numerous buyers similar to its off-price peers. While it tends to pay its vendors quickly to achieve better pricing, it likely could quickly and easily increase its cash flow by paying suppliers on more normalized timelines, an upside opportunity not factored into our analysis.
Though not immune to competition, CTRN does operate a truly unique retail models by offering the buying power, brands, and prices of national off-price players with the environment of a local specialty store.
Furthermore, while its core customer is experiencing strong demographic tailwinds, they have not migrated online to Amazon and other e-commerce stores for a variety of reasons, including lack of credit cards (CTRN processes a very high percent of cash transactions) and secure delivery sites. Like other off-price retailers, CTRN offers consumers more of a treasure hunt that is difficult to replicate online and also tend to spend very close to need and/or when funds become available. This is clearly apparent when looking at the impact of events like annual federal tax distributions/returns, a source of transient seasonal volatility for CTRN. While Amazon focuses on Prime, CTRN continues to focus on its underserved and ignored customers.
CTRN has grown from a 200 store ~$200M revenue business in 2004 to a 550 store ~$700M revenue business. Today, CTRN commands a tiny $170M enterprise value versus an enterprise value of more than $650M when viewed as a growth company.
CTRN has returned to top-line and bottom-line growth after a few years of growing pains and operational issues. Results in recent quarters have only re-affirmed this trend, which we expect to continue for the foreseeable future. Despite its operations turning the corner, CTRN’s valuation remains depressed with EBITDA multiples of ~4.0X.
In addition, CTRN owns a fortress balance sheet with nearly $90M of cash (>30% of market cap) and no debt.
More specifically, CTRN has turned its same store sales positive in recent quarters and seen widespread improvements across categories, a rarity in retail today.
CTRN reported very impressive Q2 results, especially in terms of same store sales. Same-store sales increased 4.6% for the quarter and are trending up ~5% into the current quarter accelerating from a 1% increase in Q1. All five categories comped positively for the first time since Q4 2014. As impressive, comps were driven by a 3% increase in the number of transactions and a 2.5% increase in the average number of items per transaction.
Gross margins remained largely flat and EBITDA margins expanded year over year, rendering the strong top-line growth even more impressive (i.e., the comps were not bought with margin). We also note that CTRN posted positive EPS in a quarter that generally results in negative net income due to strong margins and top-line performance.
In a quarter where companies like Urban Outfitters (URBN) were rewarded for merely producing less negative same store sales and earnings, we remain baffled by CTRN’s share performance. CTRN unexplainably collapsed ~20% before Q2 earnings (likely due to macro retail worries and to, a lesser extent, concerns about CTRN’s ability to meet expectations) and has yet to reclaim that share price decline despite strong Q2 results and unexpectedly aggressive share repurchases.
Activism and Shareholder Return of Capital
In March 2017, Macellum Advisors nominated four directors for election to CTRN’s board after which CTRN and Macellum engaged in a somewhat messy confrontation through a series of publicly issued letters to shareholders. During this process, CTRN’s CEO resigned and an interim CEO was installed (existing and very qualified CFO/COO). In late May 2017, Macellum’s managing partner was elected to the board despite the opposition of CTRN’s existing board members. We were disappointed that the very generously paid board elected to spend $2M of shareholder capital fighting a shareholder with a demonstrated track record in retail. We welcome this shake-up as it helps ensure that shareholder interests are prioritized.
Thus far, Macellum’s activism has resulted in:
- Resignation of CEO Jason Mazzola in March 2017 and installation of interim CEO (current CFO) – blood is floating in the water
- Authorization for $25M of share repurchases which was exhausted aggressively in a single quarter (Q2)
- Increase of 33% in dividend
- Reported stellar Q2 results
We expect more positive proceedings from a motivated activist and refocused management team. We also note that CTRN has yet to authorize a new repurchase authorization, a situation that should be remedied in the near-term. Though our base case assumes that CTRN will continue as a standalone business, we believe that CTRN be taken private (possibly in the near term especially without a permanent CEO in place) if the shares continue to underperform.
Overstated Market Capitalization and Enterprise Value – the True Multiples
CTRN repurchased 1,197,000 shares in Q2 2017; however, only a fraction of that repurchase is reflected in Q2 income statement while the cash balance fully reflects the repurchases. We calculate CTRN’s actual share count as 13.6M shares vs. Q2 2017’s reported 14.4M shares. At CTRN’s share price, this discrepancy equates to ~$15.2M or >$1.00 per share which will be formally “remedied” when CTRN reports Q3 in mid-November.
In addition, Bloomberg and other financial data service providers understate CTRN’s cash & equivalents balance in their enterprise value calculations. CTRN carries ~$27M (~$2 per share) of liquid, long-term investment securities (largely US treasury bonds/notes and bank certificates of deposit) which are not included in CTRN’s enterprise value for reasons that baffle us. If we include this cash-like line-item, CTRN’s enterprise value and valuation multiples based on enterprise value (i.e., TEV to EBITDA) shrink by ~14% without any change to business fundamentals.
Incorporating the true share count and cash & equivalents balance, we estimate that CTRN’s enterprise value to EBITDA multiples are overstated by more than 1.0X. Whereas Bloomberg shows a 4.9X forward multiple, we argue that the true multiple is 3.9X, a full turn lower.
We analyze CTRN’s earnings power under a range of scenarios. At 4.6X our low case and ~4.0X our base case, CTRN is trading at an unwarranted discount to a growth retailer insulated from online headwinds.
Our view on CTRN’s valuation is triangulated from peer multiples, recent sector M&A, and our proprietary LBO analysis. All three methods suggest that CTRN is worth ~$27 to $37 per share versus its current price of ~$19.
CTRN is being lumped into the secularly challenged small cap specialty retail peer group and assigned an extremely undemanding multiple (an even more undemanding multiple when considering CTRN’s true enterprise value). We consider small cap specialty retail multiples a low case for CTRN.
In our view and given stable traffic, positive comps, everyday low prices, and off-price sourcing strategy, CTRN should be compared to off-price department stores such as Burlington Stores (BURL) which trade at far higher multiples. To compensate for its smaller capitalization and smaller store fleet, we deduct 2.0 turns from the mean multiple for our high case.
Though out of favor, the retail space has seen some recent M&A such as Staples and West Marine being acquired by private equity firms in 2017. Multiples range from 5.0X to 7.5X trailing EBITDA suggesting a valuation range of ~$21-28 for CTRN.
Given its pristine, unlevered balance sheet and stable cash flow, CTRN screens well as a leveraged buyout candidate. Our conservative no growth or margin expansion base case supports a ~$24-25 take-out price with 25% sponsor hurdle IRR. Our modest upside case of 2.5% revenue and EBITDA growth supports a ~$28 take-out price with 25% sponsor hurdle IRR. Our downside case of 2.5% revenue declines still supports a $20-21 take-out price. While a theoretical exercise (unless or until a transaction occurs), our LBO analysis provides an incremental layer of comfort with our long thesis and valuation downside.
Other Factors to Consider
- Real estate. CTRN owns three properties, including corporate headquarters in Savannah, Georgia with no debt
- Tax reform upside. Given its ~37% tax rate and 100% domestic revenue, we estimate ~15% accretion should corporate tax rates fall to 30%
- Lack of analyst coverage. Only one analyst covering, which serves as a blessing and a curse. We believe that continued business momentum will attract new investors and analyst coverage
- Retail out of favor. Retail remains out of favor, which has compressed CTRN’s multiple irrespective of business performance
- Store growth. CTRN continues to grow its store base very modestly. While we believe that new stores generate attractive ROIs, we continue to monitor store growth vigilantly to ensure that hurdle rates of return are being achieved.
- E-commerce disruption. While CTRN has experienced nearly zero impact from online competition, it will eventually face some e-commerce threats or need to build its own e-commerce capabilities
- Up to 20% of stores located within path of Hurricanes Irma and Harvey. However, CTRN stores generally located inland away from expensive coastal real estate. Nonetheless, CTRN does face this transient risk
Please see attached fully formatted memo with detailed tables, charts, and analysis.
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