Cato: $10 A Share In Cash And Investments, Debt-Free, With Recovery EPS Potential Of $2.00-2.50

Summary

• Cato has a 27 year record of continuous profitability, with remarkable 6%+ net profit margins, and 50%+ adjusted ROE the norm, including its best year ever in 2015.
• A risky and overly ambitious rejiggering of merchandising has resulted in dramatic comp sales and profit declines for 20 months now, causing the stock to swoon from $45 to $11.
• The company has been wrongly cast aside as "troubled retail," even though management is fixing the problem, and returning to its tried-and-true ways, with the new assortments currently flowing in.
• The company has $10 a share in cash and real estate held for investment and no debt, a huge margin-of-safety, making the stock way underpriced in any turnaround scenario.
• The CEO is seasoned, brilliant, has an exemplary record as a merchant, has been in charge for 20 years, and is fully aligned with shareholders.

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Source: Company website

Introduction

The Cato Corporation (NYSE:CATO) was founded in Charlotte, North Carolina in 1946 by Wayland Cato, Sr., his son Wayland, Jr., and brother Edgar. The company's current business model has been in place for a few decades now, with third generation scion John Cato, 67 (son of Wayland Cato, Jr.) having been CEO for roughly 20 years now. (Company cofounder Wayland Cato, Jr., while no longer involved with the business, is a rather vigorous 95 years old, which may imply no immediate need for a succession plan at the company.) John Cato has a 9% economic interest in the company, but also controls super-voting shares, which give him 43% voting control. The company originally went public in 1968, then private in 1980, then public again in 1987.

Cato operates roughly 1350 stores (all leased) in 33 states, primarily in the Southeast, and primarily under the Cato, Cato Fashions, and Cato Plus names, but also under the It's Fashion, It’s Fashion Metro, and Versona names. The key to the business model is that the company offers on-trend ladies apparel and accessories at every day low prices ($29.95 dresses, $27.95 jeans, etc.) in a full service environment, where colors and styles are coordinated and presented for ease of selection. Cato locates its stores mainly in small town and secondary markets in strip centers that also include a Wal-Mart Supercenter and/or market dominant grocery store, which provides a steady stream of traffic, making the company highly resistant to the secular decline in shopping mall traffic. Unique to the company's business model, while it does have stores in medium cities, it purposefully avoids locating in the urban core, to avoid high rental costs, instead locating on the city outskirts.

Cato has emphasized broad and shallow assortments, in order to minimize markdowns, create a more dynamic and exciting retail environment, and to facilitate a more nimble-reacting buying operation. The company offers quality merchandise that is generally priced below comparable merchandise offered by department stores and mall specialty apparel chains, but is generally more fashionable than merchandise offered by discount stores. This creates a kind of value-added in store "treasure hunt" shopping experience for customers. The company seeks to be the leading retailer for fashion and value in its markets, and believes it is the every day low price leader in its market segment.

The Company Became A Financial Powerhouse Shortly After John D. Cato Took Over As CEO In 1999

Except for the last two years, 2016-2017, Cato has essentially been in a period of continuous improvement since 1990 (when the company was threatened with insolvency). Notably, this success ramped up considerably with John Cato's installation as COO in 1996, and then CEO in 1999. From 1996 through 2015, under John Cato's aegis, the company went from $492 million in sales and $7 million in net income to $1 billion in sales and a record $67 million in net income. Cato has evidenced himself to be a very shrewd merchant and buyer, surrounding himself with quality people, and, until very recently, possessing a consistent ability to execute, and provide shareholders with outstanding returns.

The company's business model has proven to be remarkably durable, with net profit margins consistently in an astonishing 6.0-6.7% range for each of the six years ended 2010-2015, which were, in fact, the best margins the company has recorded at any time in its modern history! Even in the recession years of 2008-2009, the company averaged between 4-5% net profit margins, and typically achieved 5-6% net margins from 2007 back to 1999, John Cato's first year as CEO. (The company has had NO loss years in the last 27 years.)

The company has had low turnover in management, with its four proxy statement listed executive officers (CEO, CFO, Director of Stores, and Chief of Real Estate/Store Development) each having been with the company for 30 or more years. This reflects the family atmosphere at the company, high morale of corporate employees, and healthy and stable corporate culture. It also should be emphasized how reassuring it is that the same core team remains in place that made this company such a resounding success over the last generation.

The Company Has A Margin Of Safety Like You Have Never Seen Before, Attesting To The Underlying Value Proposition

First of all, the company is carrying $220 million in cash on its balance sheet, or $8.85 a share. Secondly, the company holds 350 acres of Charlotte-area real estate for speculative development, adjoining an interstate highway (I-77).

While this land is carried for only $11 million on the company's books, I estimate it to be worth $75,000 an acre, or roughly $25 million. Combined, the cash and land represent roughly $10 per share in "excess" asset value for the company. That means, at an $11 stock price, investors are essentially paying only $1 per share for a debt free business. At $1 per share, on 25 million shares out, one is paying $25 million for a business that is generating roughly $1 billion a year in sales and has earned, in the best of times, $67 million in net profit! Effectively, one is paying, adjusting out the cash and investments, LESS THAN ONE TIMES RECENT PEAK EARNINGS FOR CATO STOCK. That is virtually unheard of, in the annals of value investing, especially in times of fully-priced stock markets (as we are in now), and especially considering the fact that even AFTER we have seen 2 year "stacked" same store sales declines of over 20% (see below heading), Cato remains a materially profitable company.

A New Merchandising Strategy That Failed Has Caused A Harrowing Decline In The Company’s Fortunes...And Stock Price

Cato was at the very pinnacle of profitability in 2015. With the stock price peaking out at $45 early that year, as the company earned record high net margins of 6.7% and a ridiculous 56% adjusted ROE (backing out the cash position), management was concerned about customer surveys which revealed that the company was "unrecognized" by the younger generation. With that in mind, in order to expand the customer base, and appeal to that younger crowd, John Cato decided to go to 100% internally designed merchandise assortments, and stop buying "from the market." If executed correctly, the strategy would have allowed the company to offer desirable exclusive merchandise at lower production costs (which would earn the company higher profits), and result in the company being more vertically integrated. But the strategy was also dangerous, because buying from the market had long been a core competency of the company that produced growth and record results, results which stood on their own merits, even quite irrespective of the arrival of the internet era in retailing.

The company began implementing the new strategy in the summer of 2016...with the results being truly disastrous from day one. First of all, the company's designers were not familiar enough with the core customer and what she wanted. Secondly, the company's historic broad and shallow strategy was sacrificed, in order to minimize the burden (and cost) of having to come up with "too many" designs. In addition, a number of designs were look-alike in their styles, further alienating customers. Finally, and perhaps most significantly, the company SHRANK its clothing sizes, and changed overall fit, ostensibly to appeal to a younger crowd, but only serving to offend the core customer and make her feel like she had "gotten fat.” Adding insult to injury, the vaunted “youth customer” never showed up!

Consequently, the company's long term record of success was stopped in its tracks in 2016 and 2017, as the company suffered double digit comp declines, generally, from November 2016 all the way through September 2017, with only modest moderation since then. Similarly, the company's net profit dropped from $67 million, or $2.39 per share, in 2015, to an expected 70-90 cents per share in 2017 (excluding a one time tax effect for the Trump Tax Act).

Management was chastened by these "merchandising missteps" (as they referred to them), and has readily admitted that they may have become "too heady," and victims of their own success. They acknowledge that they should have tested the program more, or rolled it out gradually. Designers needed more time to study the company's customer base first, before pumping out product willy-nilly.

With The Company’s Historically Strong Positioning In Its Markets, Record Of Successful Merchandising, And Bedrock Balance Sheet, The Problems Are Eminently Fixable

Fortunately, the solution to the problem is almost as simple as the problem itself: Regain the loyalty of the customer base by going back to "buying from the market," and change back the sizing and fit of clothing to what the customer base has come to expect. It seems hard to believe that John Cato would take for granted his and his buying team's historical abilities to scour the marketplace and “buy right,” giving his customer base a dynamic and varied array of offerings that always pleases her, and has earned the company a loyal fandom. The notion that a skillset of surveying the landscape and cherry-picking the best of what the marketplace has to offer, reacting to hot trends, etc. would be interchangeable with the ability to become a full-fledged design house, overnight, seems rather hubristic to this author. But what is comforting about the situation is that this is not a management team that pulls its punches; it has taken full responsibility for the failure, and while it may have initially been fumbling around trying to make tweaks to the new system, when it found out that wasn't working, management was faster in "putting things back" than, say, J.C. Penney was, after the Ron Johnson fiasco (a situation that resulted in shocking 25% comp declines for JCP). Cato management has communicated to the Street that a return to "the old Cato," from a merchandising perspective, is being fully effected, and will be fully implemented, by the end of the current (first) quarter of this fiscal year. THEREFORE, SHAREHOLDERS WILL NOT HAVE TO WAIT LONG TO SEE IF THE REPOSITIONING OF THE COMPANY RESULTS IN THE HOPED FOR RETURN TO STABILIZED, AND EVENTUALLY INCREASING, COMP SALES.

A Confluence Of Circumstances Has Knocked The Stock Down To Extraordinarily Depressed Levels

A combination of 1) 20 months of comp store declines that are running over 20% now, on a "stacked" basis, 2) the closely held nature of the company, with a perception of insularity and “mysteriousness” by some on the Street, 3) the fact that the company doesn't conduct earnings conference calls, and has little analyst coverage, 4) general fears around long term prospects for brick and mortar retail, combined with 5) the fact that Cato only has 2% of its sales coming from the online arena, as well as 6) short sellers sowing fear and doubt around the reliability and trustworthiness of Cato management, have all served to ramp up uncertainty and jitters here. In addition, 7) the extraordinarily high dividend yield (over 11% currently), and ultra high cash balance, cast a perverse pall on the stock, with some seeing the yield as "unsustainable," and the cash balance as representative of truly inexplicable and unjustifiable capital inefficiency on the part of management (or even perversely validating the notion that so much capital is "needed" because management may have little faith in its own future).

As Cato Only Realizes 2% Of Sales Through Digital Channels, Misperceptions That It Is “Behind The Curve” On Omnichannel May Be Just One More Reason The Stock Is So Irrationally Undervalued

While it seems clear to this author that the downturn in Cato's fortunes is the result of a discrete and sudden set of events that represent little more than the company shooting itself in the foot, there is no guarantee that returning merchandising back to "the way it was" is going to bring about the earnings recovery that would be fully expected. But, and it is important to note, since the Street has essentially priced in COMPLETE FAILURE as the most likely outcome (and a continued erosion of same store sales), there are asymmetric benefits to be had, should the company be able to turn itself around. And while it is certainly possible that some portion of the sales decline of the last 20 months may be due to fundamental changes in the marketplace, and the way the Cato customer buys her apparel (including increased internet purchasing), the FACT that Cato achieved 27 year RECORD HIGH net profit margins in 2015 compellingly argues that if the company's lack of omnichannel wasn't a problem in 2015, it certainly couldn't have become the lion's share of any problem, VIRTUALLY OVERNIGHT. Additionally, to its credit, Cato management has been making a conscious effort to ensure that it maintains appropriate margins with its omnichannel efforts, and not "give away the store." This is unlike other retailers, such as BBBY and PIR, that seem to be panicking like deer in the headlights, and undermining their business models by chasing unprofitable omnichannel sales just to "compete" with Amazon. (Just for example, Cato charges $6.95 shipping on all online orders shipped direct to the customer...but free if shipped to the store, avoiding the indiscriminate cannibalization we have seen at other retailers.) This author believes that the value-add of the Cato model is inherently tailored to bricks and mortar, considering the low price nature of its model, the appeal of the shopping experience to the customer, the fact that Cato matches up outfits on the sales floor for customers, the fact that sales associates often have personal relationships with the mainly small town customers, and the fact that she oftentimes wants the outfit NOW. (In addition, since Cato deals in FASHIONS, the model is one that stands apart from the flocking to digital purchasing that exists for commodity type items such as media, groceries, shoes, or even clothing basics that are more easy to buy online, sight unseen.)

Short Sellers Have Been Tarring And Feathering The Company, Gleefully Sowing Fear, Doubt, And Insecurity, And Casting A Pall On The Company

Despite the fact that the company has otherwise been a reliably stellar performer (as indicated above) over many many years, and the nature of the company's merchandising missteps are rather straightforward (albeit seriously negative), the shorts have been "piling on” and shamelessly trumping up all manner of sensationalistic charges, red herrings, and innuendo. From allegations of accounting manipulations involving a change in estimate for gift card breakage, "running" sales through foreign subsidiaries, and "suspect" donations of inventory, to "artificially low" tax rates, and "desperate" and "impossible" cuts to SG&A, the list is a rather clever, but completely transparent, Pandora's box of motley and sundry charges. I investigated a few of the charges, just to assure myself that Cato management is on the up-and-up, and I have satisfied myself that such is the case. One example involves Cato's change in estimate for gift card breakage, which involves the accounting methodology for crediting back the income for expired gift cards. Cato was taking up to 5 years to bring the gain from expiration back into income, which is a very conservative practice. In this past fiscal year, their auditor told them the practice was TOO conservative, and asked them to do a catch-up, so that the income is taken in within a year of the expiration of the card. Since such change of accounting principle resulted in a one-time gain to Cato, one short seller presumed that this was an effort to game the system and essentially hide the decline in Cato's operating results using sleight-of-hand, by taking the offsetting one-time gain. But such was NOT the case, as the change was requested BY THE COMPANY'S AUDITOR. Similarly, the same short seller suggested that Cato's "artificially low" tax rate was suspect, and that donations of inventory to charity were highly suspicious. Yet, in my investigations of these matters, it became clear that the company was actually being incredibly SAVVY with regard to donations of inventory. Specifically, inventory that had been marked down to almost nothing, and still had not sold, is donated NOT to Goodwill or the Salvation Army, but to non-profits that help women apply and interview for jobs. In this way, the inventory can be deducted for an amount that is greater than its carrying value on the company's balance sheet (but less than retail), because the woman is using it for a higher purpose involving job-seeking, and not just as an "article of clothing." (Inventory donated to charities like the Salvation Army can only be deducted for its fair market value.) The explanations from the company on these, and other matters, are very clear and straightforward, but at least one short seller, who has made a litany of spurious allegations against the company, at the same time remarkably admits that he has NEVER spoken with management, which is a rather disturbing tell-tale.

The Company Has Bought Back Stock, And Insiders Have Bought Stock In The Open Market As Well, Signaling Confidence In The Company's Long Term Prospects

As a result of company stock buybacks, the share count has been reduced from 29.25 million shares in February 2014, to 26.6 million in February 2017, to 24.8 million at November 30, 2017, an overall reduction of 15%. Being that the company paid an average of $13.05 per share with its most recent November 2017 purchases, and there are over 600,000 shares remaining on the buyback, I believe that a turnaround in the company's fortunes would likely result in a rapid completion of the buyback, and there is a very good chance that management would increase the authorization, as well. Importantly, the company has executed on this buyback while paying a hefty dividend AND maintaining the bulk of its gargantuan cash hoard...a testament to the remarkable cash generating capacity of the business, over time. In addition, while the quantities are only modest, 3 different insiders bought stock in the June-Aug 2017 time frame at between $14-17 a share, a significant premium to the current price. And the CEO even exercised options on April 11, 2017 to buy shares at $23.56, which can only be interpreted as a clear "show of faith" in the stock (which was trading at six year lows, at that time), since the prior day close was $20.89.

The Company Has Historically Been A Generous Dividend Payor...And A Reliable Dividend Increaser

Since reinstituting a dividend in 1992, Cato’s dividend has been increased or left unchanged, every year, for 26 years. Moreover, to show how far the company has come under John Cato's management, the company paid a 19 cent dividend in 1998, one year prior to Cato becoming the CEO. The dividend is now $1.32 annually. (Hearteningly, the company just declared its regular 33 cent quarterly dividend on March 1st.) In my opinion, there's a very good chance the current dividend will be maintained, considering the strength of the balance sheet, and the short to intermediate term likelihood of a turnaround in the company's operations. (Even in the depressed 2017 year just ended, the lion's share of the dividend was funded with free cash flow generated from operations.) Of particular import is the fact that with the company being massively overcapitalized, I believe there is a high degree of assurance that any kind of material upturn in the company's sales and profits will secure the continuation of the $1.32 annual payout. And once the Street again believes that the dividend is safe, it could be a huge catapult for the stock price, as income investors decide that a 5-6% yield is more than adequate compensation for a Cato that is on the mend, versus the current 11%+ yield.

Will John Cato Find It Irresistible To Make A "Low Ball" Bid For The Company, Especially If There Is A V-shaped Recovery?

Interestingly enough, the company had previously been taken private by John Cato's father in 1980, and there is no reason it couldn't happen again! While, certainly, no outside shareholder is interested in having the company "taken away" at a low-ball price (especially at the inflection point of a major turnaround), it is worth performing an analysis of how a management led buyout might look, just to reinforce how tempting it MUST BE for John Cato to consider, and revealing, in one more way, how dramatically undervalued the Cato franchise is. So, just for example, to buy out the 22.3 million shares owned by outside shareholders at a low-ball price of $18, Cato would have to come up with about $400 million. $220 million could come from the company's cash hoard, and the other $180 million financed with debt. Considering the company consistently achieved EBITDA of well over $100 million annually for six years running from 2010-2015, the ratio of debt to historical EBITDA would be very manageable indeed, at under 1.75x. Even at the currently depressed level of EBITDA, the leverage it would require to "take out" the company, at $18 a share, would be just under 5.0x EBITDA, a still reasonable number. Tantalizingly, any sudden "inflection" in comp sales results to the positive, without a rapid snap-back in the common stock price, could markedly increase the potential of a buyout, as the confidence of potential lenders would climb rapidly, and set us up for exactly the scenario in which management might not be able to resist pouncing on the opportunity.

Valuation And Price Targets

It is my belief that a combination of 1) a return to the old "buy from the market" merchandising strategy (with a return to INCREASING comp sales), 2) the 15% reduction in the share count we have seen (including the high likelihood of additional stock buybacks as any turnaround takes hold), 3) the reduced SG&A we have seen, 4) reduced store openings along with a focus on driving profitability at existing stores, and 5) a lowered federal tax rate under the Trump Tax Act (the company has historically paid between 33-35% of its income in taxes, in good years...a figure that should come down in any earnings recovery), should all serve to return the company to record EPS within a few years. In such a longer term scenario, if the company returns to $2.00-2.50 in EPS, a conservative 10-14 multiple on that number seems appropriate, considering the out of favor nature of retail right now. Taking such a multiple, and adding in HALF of the previously noted cash and investments per share, would yield a stock price target of $25-40. This, indeed, is my 2-3 year target for Cato stock. In the intermediate term, it is my belief that same store sales declines will begin to moderate, based upon the new merchandising, and return to positive growth by summer. Under such a scenario, I would expect the stock to return to its historically "depressed" trading range of $20-25, within 6-18 months. Moreover, in any turnaround scenario, I believe it is highly likely that the company will continue to pay its $1.32 per share annual dividend. If such is the case, I believe another way to value Cato is to set its valuation at a 5-6% dividend yield, which would imply a 6-18 month target price of $22-26. Finally, I believe that in a shorter term 3-6 month scenario, that involves simply a flattening in comp sales results, the effect of investors suddenly believing that the sky is no longer falling would be a huge collective sigh of relief, and that such an occurrence would be likely to return the stock to its recent highs in the $16-17 range.

Concerns/Risks To The Upside Scenario

After 20 months of same store sales declines that were caused by a compromise of Cato's "treasure hunt" experience, and the insult of ill-fitting product, some customers may view the company's actions as a slap in the face. Such customers may never come back and, in this sense, the damage may be done. On the other hand, one only need look to J.C. Penney for an example of how even a catastrophic collapse in same store sales can be slowly recovered from. In addition, Cato is still profitable, as we speak, so it doesn't need to recover all of the sales it lost. Even recovering 1/3 of the sales lost would cause a significant "bounce" in the stock...and recovering 2/3 would be a stupendous outcome, for restoring shareholder value.

Management's merchandising miscalculation, and maintenance of a ridiculously overcapitalized balance sheet, is evidence of the need for more independent thinking and oversight on the board, including one or more new independent directors. But concentration of 43% voting control in the Cato family creates the risk that such changes may never be made, or even considered. (The announced expansion of the Cato board, on March 1st, from seven to eight members, and appointment of a Charlotte area university president...who already serves on three other boards...appears to be more of the same.)

The recent increases in the wages paid by stores like Walmart, Target, etc., may pressure Cato from the cost side. Yet, management has voiced an opinion that increases in the low end of the wage scale are a wash for the company, at worst, and may actually be a benefit. (In effect, the upshot of increased wages on the low end of the socioeconomic scale is that Cato's customer base is more flush with money to spend...at Cato.)

The company has been depending on John Cato for its success for a generation now. The lack of a succession plan could lead to the risk of the company not being nearly as profitable as it once was, if it loses its chief merchant. (On the other hand, John Cato is only 67 years old and quite vigorous, and his father is doing well at 95 years old, so there may be a number of years to go for John Cato to run this show.)

In the end, the company's lack of omnichannel penetration could mean that the times are leaving them behind, and an “insular” management is “in denial,” or simply doesn't have the right skillset to move the needle (a belief I obviously disagree with).

Catalysts And Upside To Outlook

This is the same team running the company that has been wildly successful for a generation. It is really about merchandising, and buying right, when you come right down to it. These are not talents that are typically "lost." For John Cato and his team, that part is like riding a bicycle. And my sense is that John Cato does not like to lose.

This is not a model that is really suited to the web. It is about needing/wanting an everyday low-priced fashion forward outfit now, wanting to shop in person to discover what is available, and receiving help from the sales floor.

When same store sales start to turn flat to positive, that is likely to be a rather rapid catalyst for the stock price to recover. Similarly, the dividend becomes a catalyst when the sales turnaround happens, because faith in the dividend's sustainability will be almost instantly restored, as it will be fairly rapidly seen as "safe" again, especially keeping in mind the company's fortress-like balance sheet.

Management is a conservative bunch and appears to have cut back on the stock buyback, with the intent to continue funding the dividend, until they see the "whites of the eyes" of a turnaround. But that means they may very well resume the buyback, as a turnaround gains traction, which would only help provide more support, and ultimately momentum, for the stock. Similarly, management could create a huge amount of value by pouncing with a Dutch Tender for several million shares, at the inflection point for same store sales, which would significantly increase EPS in the recovery, and likely create a virtuous cycle for a very favorable stock price move.

Conclusion

By any and all valuation metrics (especially after adjusting one's purchase price by backing out the cash per share), Cato Corp. is remarkably undervalued. Whether looking at its price/book, price/sales, price-to-historical-earnings, historical ROE, EV/EBITDA, or the fact that the company pays an 11%+ dividend that is likely sustainable, the Cato valuation story truly stands out, in the annals of deep value stock selection. The story is a relatively simple one of an overly ambitious management team that, like Icarus, got too close to the sun, with its waxed wings. But unlike Icarus, the situation for the company is NOT fatal, and management is in the final stages of "putting things back to where they were,” so that most or all of the lost sales and profits can be restored. Cost cutting and a 15% share count reduction, over the last few years, along with a reduced federal income tax rate, make it more likely than not that the company can and will return to historical profit levels of $2.00-2.50 in EPS, over the next few years, which would result in a stock price that could be expected to roughly triple from the current price. This is a fantastic business that has historically thrown off huge amounts of cash, and the current cash balance masks the inherent capital efficiency of the business itself. The model works and even has a "moat" of sorts around it, with roughly 2/3 of stores located in towns of 50,000 people or less. (In many locations, Cato may be the only nearby place to purchase everyday low-priced, fashion forward women's apparel.)

Third generation scion John Cato is a seasoned merchant, who can readily pick himself up off the floor, dust himself off, and go back to buying right, buying smart, and being the great merchandiser that he has PROVEN himself to be. He is vested for the long term, with 9% economic ownership of the company, and will not "blow up" the company. The Cato family has been operating this company for over 70 years. This is a family name where retail courses through its blood... lower profile, to be sure... but clearly deserving the recognition accorded to more well-known and storied retail names such as the Leslie Wexners, Nordstroms, Dillards, and Waltons of the world. Cato stock is drastically undervalued and completely misunderstood. Most importantly, I believe it is highly likely that the turnaround at Cato Corp. is HERE and NOW.

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Analyst’s Disclosure: I am/we are long CATO. 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.

Comments

[tenbaggerZ!!]

Item 2. Properties:

The Company’s distribution center and general offices are located in a Company-owned building of

approximately 552,000 square feet located on a 15-acre tract in Charlotte, North Carolina. The Company’s

automated merchandise handling and distribution activities occupy approximately 418,000 square feet of this

building and its general offices and corporate training center are located in the remaining 134,000 square feet. A

building of approximately 24,000 square feet located on a 2-acre tract adjacent to the Company’s existing location is

used for receiving and distribution of store and office operating supplies. The Company also owns approximately

185 acres of land in York County, South Carolina as a potential new site for our distribution center.

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This is from 2016 annual report. The same holds for 2017, 2018, 2019. Not sure where you get the 350 acres of speculative development land in Charlotte. Apparently one should not attribute that ~$2/share to the company if that is not the case. Plus based on their filings, they have absolutely no intention whatsoever to develop those 185 acres in York County.

[rjm22]

If you click on the link above regarding the 350 acres, it mentions a joint venture. Not sure how its listed on their balance sheet.

[tenbaggerZ!!]

Interesting. they did not mention anything related with this JV in their 2019 10K at all. probably lumped into "other assets" of 20 mil, but no way to verify really. Thanks for pointing this out, I did not see the link initially.

Anyhow I think this thesis was previously quite nicely laid out, and sort of confirmed by the reality (2018 comp store growth 0%, while 2019 comp store growth 2%, as the management team reverts back to the old merchandising model while shuttering unprofitable stores)

Nevertheless, at the moment this thesis in its original form is completely busted. Cash depleted from 212 mil in 4Q2020 to 137 mil. Yes they have cash and they have revolver undrawn of ~30 mil so they'll be fine. I'm glad the management is as prudent as they have been rather than like what the author said in terms of being overly conservative and so on. But when we got through Covid they'll probably be holding only 50 mil cash so you basically get a 6x PE retailer out there that does not own any land like BBBY or Macy's (operating lease expense 66 mil and total obligation >200 mil).

Plus read some comments by the author recently and he's just as confident and optimistic when he said Phi. Inc was a generational buy (whereas I shorted the stock from 15 to 1.9...). Would probably adopt a "wait and see" approach regarding this name. Plenty of better investment theses out there in the market.

[Montrealer]

What's up with CATO? Is the recent price action just retail sector related or CATO specific?

[Opportunistic Fox]

Cato was a phenomenal call. Kicking myself for staying on the sidelines based on my judgments over the business quality and integrity of management.

At what point do you guys get short? I may nibble around 25 and increase exposure near 30.

Shoe Carnival is another interesting short candidate. Half a billion business selling discounted sneakers, primarily from Nike, in rural midwest markets. Doubled from 2017 lows at all-time highs.

[Michigan Value Investor]

Short? I almost wrote "You are out of your mind to be short at $25", but then I thought better of it and decided to ask what your reasons are instead.

Cato will probably be earning $2 and they have $10 a share in cash and other assets. Unless you have some visibility into earnings heading down from here, why be short?

[Opportunistic Fox]

Maybe I am insane. I'm not optimistic on $2 per share earnings long term. I also think management will destroy a considerable amount of value - especially if sales begin to deteriorate. I think its telling that nobody attempted to acquire CATO at 11, even when the company was 80%+ cash.

Cato is an ugly business. You'd be crazy to set up shop selling cheap clothing near Walmarts in strip malls across the country. There are far worse retailers out there relative to Cato, but I'm definitely not going long after this thing doubled. I'll probably short small (<1% of capital) as a contrarian anti-retail play.

If you still own shares, you are essentially making a conscious decision to purchase Cato today as opposed to owning something else. I understand not shorting on the basis of value, but I'd strongly recommend exiting a long position.

[Michigan Value Investor]

I don't own any shares. It was a 10% position for me at $11 and as the price rose I sold shares, the last of them at $21, you can read my comments going all the way back to Vince's write up where I outline my thinking from $11 through $21.

My usual plan is to buy cheap, sell on the way up, and be all the way out before fair value. I'd say $25 might be decent guess at fair value, which explains why I was out at $21. But why would you want to be short a volatile stock at fair value? I'm short sometimes, but this doesn't make sense to me. As far as it being an ugly business, maybe, but a 7 PE after backing out the cash makes it not necessarily expensive.

And as far as being crazy setting up shop next to a Walmart, I think you are missing something. The model has worked pretty well, and is working today. Not crazy, successful.

[Oleg43]

Tim,

If you do not mind me asking on ODP thesis. I mean outside of the fact that their nearest competitor was purchased @2 times on any given measure.:)

Do you believe in the concept of switching from retail to service entity in general? It seems to be a highly competitive market where Compucom does not look as a preferred solution. I kind of doubt their ability to become the major driver of earnings growth going forward. And their core market seems the most obvious target of Amazon.

[Timothy Stabosz]

I have no long term conviction either way in ODP. The stock is simply oversold, based upon the FCF yield, revision of guidance higher for 2018, and expression of anticipation of improved results in 2019 as well, in the most recent slide deck the company just released. The stock is going to $4, and I will start selling at $3.50, and sell out completely by $4, in the near term, or if the rally is slow and steady, sell out by the mid to high $4s.

[jimmyjons]

ssstasss & Play Your Best Game,

Seeking Alpha allows you to view each contributors comments by ticker. By reading the contributors comments in this manner, the majority of these questions can be answered. Just to save everyone some time.

[Shangrila Value]

Thanks :)

[Timothy Stabosz]

I am a buyer at $2.55 and down on TUES. (I sold half my position at $2.95, this week....bought at $2.55 a week or two ago. I will sell the rest at $3.35-3.50.)

See my posts on the CBK earnings release here on SA for commentary on that one. Short answer: I got mostly out after the earnings release at 80
Cents. While there has been some inside buying the last few days, i still remain cautious, and am more inclined to buy back in on a drop to 60-65 cents. (I believe CBK is probably going to die in a couple years.)

[Play Your Best Game]

Thanks again. I owe you a beer or two.

[Shangrila Value]

Thanks. About TUES, besides the stock price itself, to you believe IN THE BUSINESS?

[Timothy Stabosz]

The TUES biz model is highly suspect....but the balance sheet is strong enough that I view the stock as a fantastic stock to swing trade, at the right price, and I will continue to do that, ongoingly and regularly.

[Play Your Best Game]

Timothy, thanks for giving your top picks, and views on CATO and the others.
You mentioned TUES and CBK before. TUES ran up some, CBK reported and plunged. Any thoughts?

[rjm22]

I have not sold a share of CATO.

When i was young, I used to shit like an elephant. I have cured myself of that habit and as a result, I have let my winners run much better than in the past.

My theory is the folks buying now are not paying attention to the yield or the 52 week low.

They are paying attention to the blue sky above and the strong relative strength.

As a result, I anticipate new 52 weeks highs.

I am not looking at any stock that must be bought right now and my money market is paying less than 2%.

Because of that, I am going to let it ride for now. Maybe with a 2-3 point mental stop.

We are 8 cents below the 52 week high as I type.

[Timothy Stabosz]

Your strategy of remaining “wed” to stocks continues to make no sense to me. Why should you own TWICE as much of Cato, in dollar terms, as you did when the stock was $12? Do you like the stock TWICE AS MUCH? Do you not view the risk as HIGHER with the stock at $24, compared to $12??

You are an extraordinary value investor, and I have always respected your abilities to hunt for the best bargains (and your TEACHING me, 20 years ago, the importance of insider buying). But your lack of an appreciation for opportunity cost, and staying in a stock out of fear of “missing out on more gains” befuddles me, and means that you are NOT generally in your own “best ideas,” at all times. Consequently, your long term returns are much lower than they could be.

Anyone that has not sold at least half of a Cato position, in this doubling of the stock in 3 months, who cannot find somewhere better to put half that money, deserves what comes to him (which is more likely than not, some kind of retracement, or at least period of consolidation, in the near term).

[Montrealer]

Sold the rest of my CATO yesterday. Dipped my toes in some ODP.

[rjm22]

You can't ever have a multi-bagger if you sell after every move.

This was a small position for me and I did not buy more when I got to read the entire bull case.

That said, I did sell half today at $24.97 as I was uneasy with the trading this morning after initially hoping they would take it up several points.

Looking back at some of my long term positions, I own XXXX as low as $2.78. Now its $28.30. I own XXXX as low as $3.73. Now its $30.81.

You remember when TUES was 50 cents. I sold as high as $18- $21.80.

These kind of "baggers" can't happen if you switch into something else after a 30-70% move.

[Timothy Stabosz]

For the record, I am now completely out of Cato, as of today. There are just too many better bargains, at this point, and it seems to me that people are piling into the stock a bit too fervently now, in the short term anyway. That having been said, I fully expect them to get back to a run rate of well over $2 in eps, over the next year or so, and so would not be surprised to see the stock back at $30+. But I’m convinced I have significantly more immediate and near term profit potential in the likes of ODP, TA, PHIIK, CNTE, ACET, SMRT, and SUMR, among others. In the meantime, if Cato has an aggressive pullback, I’ll possibly be adding as high as just above $20, and certainly in any retracement to the low $18s.

[Montrealer]

Is your list in order of conviction? In your view, which one has the least downside? I am long PHIIK (and CATO).

[Timothy Stabosz]

It is not. It is random. I can’t really say which one has the least downside. In the near term, or long term?? I really think they’re all pretty much washed out, and have bottomed, although SMRT went too far too fast (like Cato), and could possible retrace to $2.50. I would say every single stock i list above has little more than 10% downside....unless the market sells off big time, of course.

[mashkiaberech]

Tim, what about CTHR? 1.6$ BV though they had a non protiable quarter, and yet, they have lots of cash and optomistic mng which have bought at ~1.3$...

[Michigan Value Investor]

FWIW I am now completely out of Cato. I believe the story has worked as advertised, and at $21 it might have some room to run, but there's quite a bit more downside and less upside than there used to be. Thanks to everyone who posted, very helpful, and especially to Tim Stabosz!

[Timothy Stabosz]

I have also reduced my position very significantly, but that is not because I don’t think
It is going higher, over time. It is more so because i think 1) near term, it has gotten much closer to fair valuation, even if I fully expect it to be $24-32 in 6-18 months, and 2) I always look at opportunity cost, and see retail stocks like TA, CBK, ODP, and TUES as considerably more attractive than Cato. (I have been adding all 4 of those this week, especially TA and TUES, as I have been selling Cato.)

[Michigan Value Investor]

Well, this one worked. Congrats Tim!

[Shangrila Value]

Will this honey jar will keep on giving?

[Michigan Value Investor]

Far from a sure thing either way. Best guess is there's more to come, but it's not as good at $20 as it was at $11.

[Michigan Value Investor]

SSS are out and it's good news. The two month period is up 1% from the two month period a year ago, and the commentary "We are starting to see more favorable sales trends and remain cautiously optimistic about our ability to build upon this improvement in the second quarter" from John Cato makes it pretty clear that a turnaround is underway. Whether that turnaround is deep and sustained or weak and temporary is not yet clear.

[TGAgrippa]

Agreed. Hard to see results as anything but good news given the context. The fact that first quarter same-store sales were down just 1 percent is a big tell in my opinion. Congrats to Tim, you and others who went long here.

[rjm22]

No early morning trades yet. 15.45-18.99 with yesterdays close of $16.28.

CATO was mis-priced at $11 but is it at $16.28?
---------------------
Charlotte article on the 7th...

This Charlotte retailer had 'a very disappointing year.' Can it turn things around?

May 07--One of Charlotte's oldest retailers, Cato Fashions, turns 72 this year. But the past year has not been one to remember.

Cato's recently filed annual report showed that the company's profits plummeted nearly 82 percent last year. The retailer is closing stores faster than it's opening them. And a major real estate project on the site of the old Charlotte Knights stadium that Cato announced three years ago continues to lie dormant.

Cato has cited a host of reasons for its sales declines, including "merchandise assortment missteps" last year, weather and the economy, according to recent earnings reports. But unlike other retailers grappling with competition from online shopping, Cato has not laid out a significant turnaround strategy.

Through a spokeswoman, Cato declined to make any executive, including CEO John Cato, available for interviews.

As more customers shop online these days, retailers have to do something creative that sets them apart from one another or they risk failing, said Steven Cox, a marketing professor with Queens University of Charlotte.

He cited Kohl's(KSS) as an example of a retailer innovating to lure in customers. The department store chain this year announced a program with Amazon.com(AMZN) that will allow it to sell Amazon(AMZN) products and accept returns from the e-commerce giant. The partnership is already helping to drive customer traffic, Cox said.

In another example, Charlotte-based Belk, acquired in late 2015 by private equity firm Sycamore Partners, uses its "Modern. Southern. Style" mantra as an identifier to set itself apart from other department stores. It has expanded its private label brand Crown & Ivy, which features bold colors and patterns, to include menswear and women's shoes.

"(Discounting is) not going to get you anywhere anymore. You've got to have something that hooks you, and now companies are starting to make that change," Cox said.

Strip-mall focus

Nearly all of Cato's 1,351 locations are found in strip malls that are anchored by national discount chains such as Walmart. Most of their stores, which average about 4,500 square feet each, are in the Southeast.

The strip-mall focus stems from a lesson in real estate that Cato learned decades ago.

Cato was founded in 1946, when Wayland Cato Jr. and his brother, Edgar, were discharged from the Navy and helped their father, Wayland Sr., open five women's clothing stores in Charlotte.

By the late 1970s, the company started to flounder, as management diversified away from the women's apparel business and kept its stores in downtown locations at a time when suburban shopping malls thrived.

The company closed dozens of its downtown stores, and settled into a formula that a former executive said in a 1987 Observer profile involves "selling the customer the clothes she wants at what Cato Corp.(CATO) calls a 'popular' price -- lower than department stores but higher than discounters." Cato first went public in 1968, then back private in 1980 then public again in 1987.

These days, retailers are focusing more often on stores in center-city and close-in neighborhoods as young urban dwellers look to work, live and play all within walking distance. That's why popular retailers like Anthropologie, Free People and Warby Parker are popping up in fast-growing neighborhoods such as South End.

A recent visit to a Cato store showed what a typical weekday looks like for the retailer.

The Cato store off Eastway Drive looks a bit like the women's section of a typical department store. The strip mall it's nestled in includes other low-cost retailers such as Family Dollar, Payless ShoeSource and MetroPCS.

On a recent Monday morning, Cato workers neatly arranged racks of pastel-colored slim-fit pants, bedazzled jeans, long patterned cardigans and bright cotton camisole tops. Prices were lower than a typical department store but not as cheap as a discounter such as Walmart: plus-sized orange pants for $24.99, a lavender striped short-sleeved shirt for $11.99, aviator sunglasses on clearance for $4.99.

Besides the rock music that played softly from a radio station overhead and the soft chatter of a customer in the check-out line, the store was quiet.

Sales slumps

Last year was a particularly difficult year for most brick-and-mortar retailers as customers opted to shop more online and as physical store traffic fell. Store closing announcements more than tripled last year to about 7,000, a record, according to retail think tank Fung Global Retail and Technology.

Big national chains that announced major store closures in the Charlotte area and beyond included Toys R Us, Bebe(BEBE), Macy's(M) and Hhgregg(HGGGQ).

Last year, Cato opened six stores and closed 26. For the year ahead, the company said it plans to close 34 stores, and that it won't open any new ones, a sign the retailer is scaling back its physical store presence like other struggling retailers are.

"With the challenges facing retail nationally and the high cost of leasing space in the current market, we are focused this year on our core business and driving sales growth through our existing store base and e-commerce. If rents decline, we are always open to strategically expanding where it makes sense," the company said in a statement to the Observer.

Other numbers are also trending downward.

Cato's same-store sales -- a key measure of any retailer's well-being that refers to sales at stores open at least one year, -- slumped 12 percent, according to the company's annual report.

Net income plunged to $8.5 million, down from $47.2 million in 2016, resulting in what the company called "a very disappointing year" because of "several mistakes in our merchandise assortment, fit and timing." Cato had to slash prices and liquidate a large portion of its slow-selling inventory, putting "severe pressure" on earnings. The company also cited a $12.3 million one-time charge in 2017 for the new tax law as a reason for its profit decline.

And over the last year, Cato's share price has fallen 28 percent. In midday trading Monday, the company's shares were down over 2 percent at $15.96.

"While Cato remains profitable, the retail environment continues to be challenging, particularly in women's apparel," John Cato, the company's president and CEO said in its annual report. A spokeswoman added the company continues to match associates' 401(k) savings and provide dividends to shareholders.

Cato's management has said to be successful, the company -- which also operates the Versona and It's Fashion brands -- has to differentiate itself from department stores, mass merchandise discount stores and competing specialty stores. Key to that goal are: its merchandise assortment, low prices, strip center locations, customer service and credit and layaway programs, the chain's leaders say.

In recent years, Cato has worked to cut costs at its corporate office. Last year, for instance, the company laid off a few employees when it reorganized its real estate department. Cato employs approximately 720 full and part-time workers in the Charlotte area.

"With fewer new store openings, Cato adjusted the size of its real estate department and other areas to align with our needs, and reduced hours and spending at some of our stores," a spokeswoman said.

Real estate woes

In addition to its retailing business, Cato made a high-profile foray into real estate development in 2014, but so far has little to show for it.

That year Cato bought (and later tore down) the old Knights Stadium in Fort Mill from York County for $844,000. The stadium, next to a baseball-shaped water tower visible from Interstate 77, was built in 1990 and was where the Knights played until 2014. Cato's original plan was to build a distribution center on the site.

A few months later, Cato switched gears and partnered with Lincoln Harris in announcing plans to redevelop the property. The massive project, which includes 350 acres of Cato-owned land, was to include 1 million square feet of office space, plus retail, residential, commercial and industrial space. Cato also owns 180 acres south of Rock Hill, which it bought in August 2015, that it says will house the new distribution center.

Three years later, Cato has not broken ground on any of it. On a recent afternoon, the site was quiet and overgrown with weeds. Trash collected in the cracked, abandoned parking lot.

Cato would not say whether its construction delays are tied to its financial performance. The company, a spokeswoman said, is "currently exploring options including a possible mix of offices, retail, residential and hospitality."

Katherine Peralta: 704-358-5079, @katieperalta

[Timothy Stabosz]

The tone of the article suggests she was pissed, because management wouldn’t talk to her, so she falsely paints the company as in disarray, because she doesn’t understand what is going on with the turnaround, in the first place. Which basically just makes the article a narrative mish-mash of stuff she could assemble together. An embarrassment, really. She quotes a professor from a school who really has no understanding of the Cato business model, but instead paints in broad asinine strokes about what “smart retailers are doing in the world of Amazon,” and implies that Cato isn’t doing that...but doesn’t come outright and say it.

I certainly appreciate your posting the article, but as far as I am concerned, it contributes little or nothing to understanding Cato (other than a few interesting historical tidbits I didn’t know).

[Defensive Value]

Montrealer, I too am not an economist. I do believe in economic cycles and this expansion is long in the tooth. That's not a prediction a recession is imminent, simply that it isn't five years away either. Your posture on this stock is eminently reasonable.

[Defensive Value]

Montrealer, I agree, EPS is a snapshot from one angle, SSS and gross margin from other angles. If they are seen as delivering $2+ EPS next year with little risk then the stock could be at $25+. It's doable, but I expect bumps along the way and accompanying stock price moves, if it happens I could move back in. Fears of a recession is one development that could possess the stock market and it would likely tank the stock. I'm not saying these fears will come to the fore in twelve months, just that it's a risk.

[Montrealer]

Thanks for the reply. I know nothing about predicting recessions or other sources of systemic or macro risk. Also ‘profit taking’ does not factor into my decision making. I am comfortable with scaling in and out of positions as price approaches value, considering available information. If Tim’s thesis is correct, I see money still being left on the table.

[Timothy Stabosz]

I support your viewpoint here. I like the way Cato is establishing a very nice base in the mid $16’s, and believe we will see a move over $20 over the next 6 months. It is still very undervalued...just not stupendously so, like it was. Management has cautioned for a decline in April comp sales, so I would think that would be already factored into the stock...but if we retrace into the $14’s, I’ll certainly be adding again. In the meantime, I’m content waiting with my remaining position. (I have sold off over 1/2 of my position, by share count.)

[Defensive Value]

MVI, I followed you and have sold my entire position in CATO. I have read and am re-reading your interview, it is one of the best explanations of what value investing is that I have read, I am certain it will affect my investing, though I doubt I'll completely shed my shoot-from-the-hip decision making style.

My CATO profits offset some of my losses on SHOS.

Okay, on to the next one, though I'll be watching both intensively.

[Michigan Value Investor]

DV - thanks for saying so! I do still own some Cato, but at this price it's nowhere near as attractive as it was at $11. I think CATO and SHOS both bear watching carefully, so we are in full agreement on that point.

In case anyone is interested here is a link to the interview:
https://seekingalpha.c...

[Defensive Value]

If you have even a passing interest in CBL read Michael Boyd's article published today. He totally obliterated the long case. The stock has 30% short interest.

[Michigan Value Investor]

OK, thanks for the tip!

[Michigan Value Investor]

The preliminary verdict is in. SSS were up 6%, but we need to account for Easter, which juiced the quarter meaningfully. They guided to down low single digit comps in March and April combined. So is that good or bad?

The answer is that it's pretty good. Let's say they are down 2% from Q1 last year - never mind February, let's just get a run rate here using March and April. In Q1 of 2017 the company earned 85 cents, so the Q1 2018 result is down from Q1 2017, but it's way up from e.g. Q4 2017. One point of qualification we need to make is that Q1 is a seasonally good quarter, so don't blindly take 85 cents and multiply by 4 for the year. But it seems pretty clear that the recovery is well underway, and we don't actually expect to see the full impact until May, so it's quite likely that Q2 will be meaningfully better (seasonally adjusted) than Q1.

[Defensive Value]

I agree, the results seem consistent with the expected 3-6 month turnaround period, they are certainly no longer in a free fall.

[Timothy Stabosz]

I also agree. I am pleased that the sales results validate the basic trajectory of the turnaround I have been looking for here. These numbers clearly signify we are STABILIZING. I would now expect a return to positive comp sales, month after month, by early to mid summer. I am very heartened. Even more exciting, my guess is it should start to get really nice on the comp sales numbers by August, when they start lapping 2 year stacked "nasties" on the comps.

[Michigan Value Investor]

For the record I am more out than in at this point. I still own some and it might do great from here, but at $16.70 it is not as good as it was when I bought it at $11.

[Montrealer]

MVI, unless their is a large difference between outcome and expectation, I still see an operating business trading at low single digit multiples. Is that what you think its worth or do you see things differently?

[Michigan Value Investor]

I think it's still good from here, just not as good as it was at $11. If it made sense to be 10% of my portfolio at $11, surely it should be less than that at $16.70. But I do still think it's underpriced, just nowhere near AS underpriced.

[Montrealer]

Thanks, my average entry is $12.50 and it was about 4% of my portfolio. I think it's way better than cash and have no alternatives to put the money in right now.

[rjm22]

I bought at $11 and turned on the DRIP at my broker.

And forgot about it when the price went up.

So my dividend went for more shares at $14.58. Hope it has a few more dollars of upside anyway.

But, Im going to remind myself to check the price in 2 months and probably turn it off before the next dividend.

[User 7529111]

Here is the old baseball stadium property:

http://tinyurl.com/ycm...

[User 7529111]

That link did not work. Here is another attempt:
http://tinyurl.com/y8b...

[Clive Fernandes]

No mention of the 350 acres in the 10-K. Are we missing something?

Item 2. Properties:
The Company’s distribution center and general offices are located in a Company-owned building of approximately 552,000 square feet located on a 15-acre tract in Charlotte, North Carolina.
The Company’s automated merchandise handling and distribution activities occupy approximately 418,000 square feet of this building and its general offices and corporate training center are located in the remaining 134,000 square feet. A building of approximately 24,000 square feet located on a 2-acre tract adjacent to the Company’s existing location is used for receiving and distribution of store and office operating supplies. The Company also owns approximately 185 acres of land in York County, South Carolina as a potential new site for our distribution center.

[Montrealer]

I could be wrong but I presume it is because the land is ‘owned’ by Cato via the joint venture between them and Lincoln Harris. If I recall, they stop mentioning the land in their ‘properties’ section of the 10-k in 2015 (i.e it is mentioned in 2014) after they established the JV. But, again, I could be completely off.