Citi Trends: The Management Of This Company Deserves A Reward In The Form Of A Higher Valuation

Summary

• Citi Trends is an American retail chain operating in the low-priced segment.
• The management's strategy of focusing on increasing the sales of the existing stores through better merchandising has shown excellent results over the past year.
• The company’s financials are rock-solid and the level of free cash is good enough for it to be a leveraged buyout target.
• Our evaluation of the company’s fundamentals and our valuation indicates that it could be an excellent buy for investors with a 1-3 year investment horizon.

The management of Citi Trends, Inc. (NASDAQ:CTRN) has adopted a relatively unconventional path in order to grow its revenues. Instead of aggressively expanding the number of outlets across the country, they decided to work on improving the core of the business - the merchandise. It was a tricky decision given the fact that the company has excellent cash reserves and zero debt, so the store expansion strategy was definitely a lucrative option.

However, the management's strategy has already started paying off. The comparable store sales are going up and the margins are improving. The company's strong financials coupled with the management's successful implementation of this strategy have made it an interesting bet for investors. Our evaluation indicates that CTRN could prove an excellent investment for a horizon of one to three years.

Company Overview

CTRN is an American retail chain that offers clothing, accessories, home products, and a vast variety of products for men, women, and children. Its product portfolio includes books, toys, electronics, jewelry, sportswear, footwear, and so on. It is known to be a relatively low-priced retailer and is known to offer heavy discounts, catering to the price-sensitive segments of the population. The company generates most of its sales through its brick-and-mortar outlets, but it also has a shopping website. Its headquarters are located in Savannah, Georgia.

The Management's Merchandising Efforts Are Paying Off

A few years back, CTRN's management was finding it difficult to achieve its performance targets. The company's new merchandise offerings were not living up to the expectations and there were issues related to the timing of apparel launches and so on. It was then that the management of CTRN decided to create a new strategy involving a more focused approach towards merchandising.

The company improved the quality of its merchandise and also worked hard on the pricing and the rollout schedules. The results started becoming visible in the last year as the comparable store sales increased by 5.6% for Q4-2017 and by a total of 4.5% for the entire year. On the Q4-2017 earnings call, the management also indicated that there was a rise in the number of customer transactions of 2.5% and the average number of items per transaction had also gone up.

This was a significant achievement by the management. Also, it is remarkable to see how a management that was struggling with merchandise rollouts a few years back is now on track to provide customized merchandise for each individual store across the country that is tailor-made for the different customer needs in different regions.

Institutional Investors Are Seeing The Value

There was a significant increase in the shareholding of institutional investors over the previous year. As we can see in the table below, the institutional shareholding of the top five players crossed 31% and BlackRock (BLK) alone seems extremely bullish on the share. If we analyze the data of the Top Twenty Institutional Investors in the company, our first observation is that more than 62% of the company is owned by institutions. Interestingly, these investments were between 47-48% before last year and have grown significantly in the past twelve months. This leaves no doubt that institutions are bullish on CTRN.

Source: CTRN/Morningstar

Projected Income Statement and Cash Flows

Annual P&L ($ mn)	2015	2016	2017	2018E	2019E	2020E
Revenues	684	695	755	779	809	841
% Growth	-	1.7%	8.6%	3.2%	3.8%	4.0%
EBITDA	42	36	42	44	48	50
% of Revenues	6.1%	5.2%	5.6%	5.7%	5.9%	6.0%
EBIT (incl. extraordinary exp)	24	19	23	24	27	29
% of Revenues	3.5%	2.7%	3.0%	3.1%	3.3%	3.5%
Net Income (Adj)	16	13	15	16	17	18
% of Revenues	2.3%	1.9%	1.9%	2.0%	2.1%	2.1%

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Source: Historical Data from CTRN; estimates based on calculations by Baptista Research

Cash Flow Statement ($ mn)	2015	2016	2017	2018E	2019E	2020E
Net Income (Adj)	16	13	15	16	17	18
+ Depreciation & Amortization	19	17	17	22	28	35
+/- Change in Working Capital	-10	4	4	4	4	4
+/- Deferred Taxes and Others	4	6	4	1	-3	-11
Cash Flow from Operations	27	40	40	42	46	45
Net Capex	-20	-24	-24	-26	-27	-29
Net Financial Investments	-25	-1	-1	-1	-1	-1
Cash Flow after Investments	-45	-25	-25	-27	-28	-30
Free Cash Flow	-17	15	15	16	18	15

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Source: Historical Data from CTRN; estimates based on calculations by Baptista Research

Dividend and Earnings Ratios	2015	2016	2017	2018E	2019E	2020E
Dividend Per Share ($)	0.1	0.2	0.2	0.3	0.3	0.3
Dividend Yield	0.6%	1.1%	0.8%	0.8%	0.8%	0.8%
Dividend Growth	-	95.5%	0.0%	10.9%	9.9%	1.5%
Dividend Payout	11.6%	26.4%	24.1%	25.0%	25.2%	24.6%
Earnings Per Share ($)	1.0	0.9	1.0	1.1	1.2	1.3
EPS Growth	-	-14.4%	12.3%	9.9%	11.3%	6.3%

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Source: Based on calculations by Baptista Research

The management has projected a 2-3% increase in the comparable store sales resulting in a 3-4% increase in the overall sales. It is safe to go with an assumption of 3.5% increase in the sales for 2018 given that the management has made it clear that it will continue to focus on optimizing its existing stores and have a limited growth in terms of the number of outlets. However, it is likely that they are being a bit too ambitious with respect to the margin expansion. The company's merchandising strategy is doing well but the management's EPS estimate of $1.5-1.7 is on the higher side. It is likely that the net income margin will not cross 2.1% and the EPS will be around $1.1.

The management's capex plans have been conservative over the past few years and the trend is expected to continue. However, on the working capital front, they might be able to further optimize the inventory levels and also ensure better receivables management resulting in good free cash generation.

There is no significant change expected in the dividend payout policy of the management. It is expected that the payouts will be consistent over the coming years in order to generate a dividend yield of around 0.8%.

Valuation: The Revenue Multiple Is The Key

EV and Market Cap	2015	2016	2017	2018E	2019E	2020E
Price ($)	20.0	21.7	30.9	34.4	38.9	41.6
Outstanding Number of shares (million)	15.0	15.1	14.7	14.3	14.0	13.7
Total Market Cap ($ billion)	0.3	0.3	0.5	0.5	0.5	0.6
Net Debt ($ Million)	-71.8	-87.3	-80.0	-85.7	-88.2	-85.8
Enterprise Value (EV adj - $ billion)	0.2	0.2	0.4	0.4	0.5	0.5

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Source: Historical Data from CTRN/Morningstar; estimates based on calculations and assumptions by Baptista Research

There is no doubt in the fact that CTRN's management has excellent skills in the field of financial management. They have been making good use of the free cash generated from the business operations by investing it back into the business. This is the reason why the company has never taken any form of debt from the market and has a highly negative net debt. Apart from this, the consistent buyback of equity by the management is making CTRN's balance sheet healthier. In fact, retail companies with balance sheets as healthy as CTRN are the perfect target for leveraged buyout (LBO) funds.

The company's share price has grown steadily over the years and the key valuation multiple that needs to be analyzed here is the EV/sales. The margins of CTRN are low which is why it would seem a bit overvalued if we look at the price to earnings but the market is known to value retailers on their revenues more than their margins. An EV/sales multiple of 0.6 is reasonably low if we analyze the industry peers of CTRN.

Valuation Ratios	2015	2016	2017	2018E	2019E	2020E
EV/ Sales	0.3	0.3	0.5	0.5	0.6	0.6
EV/ EBITDA	5.8	6.0	7.5	9.1	9.5	9.6
EV/ EBIT	10.4	12.0	13.7	16.8	17.1	16.4
Price/Earnings	19.3	24.5	31.1	31.5	32.0	32.2

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Source: Historical Data from CTRN/Morningstar; estimates based on calculations and assumptions by Baptista Research

Based on this multiple, we get a target price of $34.4 for 2018 which seems reasonable. However, if we look at an investment horizon of three years, a target price of $41.6 seems to be an excellent bet for value investors. The company is expected to continue paying dividends at a yield of around 0.8%, so the company's share becomes a lucrative buying opportunity at the current market price of around $31.

Risks

The valuation of CTRN in this article is specific to the date of the analysis - i.e., 12th April 2018. A valuation of this nature is necessarily based on the prevailing stock market, financial, economic and other conditions and industry trends. Valuation is not a precise science and is subjective in nature and dependent on the exercise of individual judgment. Therefore, it can be concluded that there is no indisputable, single valuation.

We must emphasize that the projected valuation and the share price of CTRN are dependent on the realization of the revenue growth, free cash flows, and the other assumptions taken into account. Our analysis cannot be directed to providing any assurance about the achievability of these financial forecasts. There is a possibility that the actual results of the company are different from the projected results as a result of unexpected events and circumstances - e.g., change in the quality of management changed investor perception regarding CTRN and the retail sector, trade recession, war, and so on. It is also likely that these differences between the actual financials and the projected financials may be material in nature.

We had no interaction with the management of the company, and we did not carry out any kind of due diligence processes to comment on the achievability and the reasonableness of the assumptions underlying the financial forecasts. Our projections are based purely on the belief in the management's ability to continue its revenue growth and sustain its current level of margins.

Conclusion

If there is one word that can be used to describe CTRN's financials, it is "robust". The management has already demonstrated its ability to boost the sales of the existing outlets and it is evident that if the company decides to expand its number of outlets in the long term, it will aim for profitable growth and not just topline growth. It will not be surprising if this company becomes the target of a leveraged buyout in the near future.

Our valuation indicates a target price of $34.4 for 2018 and $41.8 for 2020. The price appreciation coupled with the dividend payouts will ensure that the returns of the investors entering the stock around $30 will exceed the NASDAQ returns. Overall, CTRN looks like an excellent investment over a long-term horizon.

Analyst’s Disclosure: I/we 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.