Did Dillard's Opt for the Right Strategy?

Dillard's (NYSE: DDS  ) , the upscale department-store chain, isn't expanding as consumer spending in the US remains low. Instead, the company is cutting its operating costs to earn more profit. This seems to be working as the company didn't do too badly in its latest quarter. Does this make Dillard's a buy? Let's analyze Dillard's and compare it to peers Macy's (NYSE: M  ) and Kohl's (NYSE: KSS  )  to find out.

Third-quarter results
In the third quarter, Dillard's earnings per share jumped 11.8% from the previous year's quarter to $1.13; analysts expected the company to report EPS of $1.00. Revenue grew 1.4% to $1.469 billion while same-store sales increased by 1%.

SG&A expenses also decreased by 40 basis points. However, the reduction in expenses was offset by increased payroll which resulted in margin slippage. As a result, gross margin shrunk to 36.8% from 37.1% in the year-ago quarter.    

What is Dillard's up to?
Dillard's has been trying its level best to reduce its operating costs during the last few quarters. For this reason, the company has taken several initiatives that include shutting down its under-performing stores. In the third quarter, Dillard's closed its Euclid Square Mall clearance location in Euclid, Ohio and it plans on closing its University Mall location in Chapel Hill, North Carolina and its Collin Creek location in Plano, Texas by the end of the fourth quarter. As these stores added operational costs while facing declining sales, this move will boost the company's margins to some extent in the coming quarters.

Dillard's management has said that there will be no short-term borrowing this year, which will keep a check on the company's cost of debt. This will ultimately result in higher margins for the company this year.

Dillard has bought back a substantial amount of its common stock since the start of 2013. From the beginning of 2013 up to the end of the third quarter the company repurchased a total of 3.9 million shares, out of which 2.4 million shares with a value of $186.9 million were purchased in the third quarter. In addition, the company is looking to buy more of its Class A shares under its additional $250 million buyback program, which was authorized in November 2013. Moreover, the company also paid a dividend of $0.06 to its Class A and Class B shareholders. Although the dividend isn't much, it has consistently grown over the past few years.

Dillard's share-repurchase program along with its growing dividend depict that the company is quite keen on rewarding its shareholders, which makes the company slightly more attractive than most of its competitors.

Fundamentals

I believe Dillard's is a value stock, as it has a low forward price-to-earnings ratio and price-to-book value. The company's borrowed capital is on the lower side, as indicated by its debt-to-equity of 53. Moreover, Dillard's debt-to-equity ratio is significantly lower than the ratios of its peers Macy's and Kohl's, which makes it less risky. Dillard's high return-on-assets, or ROA, reflects its ability to generate income through efficient use of invested capital.

Competitors
Even under such economic challenges, Macy's performed quite well during its third quarter when it exceeded analysts' expectations. Revenue for the quarter grew 3.5% to $6.28 billion, while earnings jumped 30.5% from the same quarter last year.

Macy's strong performance is attributed to its new promotional activities, which have become a key growth driver for the company. While margins declined slightly because of expenses related to these activities, comparable sales rose by 3.5% during the quarter. Macy's expects its same-store sales to grow even further in the fourth quarter, and forecasts full-year earnings per share to be in the range of $3.80-$3.90.

Kohl's missed its expectations in the third quarter as its sales and earnings declined by 1% and 1.6%, respectively, from the previous year's comparable quarter. Same-store sales also dipped by 1.6%.

Kohl's is constantly facing intense competition from high-end as well as low-end retailers, which is pushing its sales downward. Kohl's is now focusing on national brands like Nike and Levi's instead of its own brands, which has been seen as a positive sign by many analysts. The company has given rather dim guidance for its full year as it expects EPS of $4.08-$4.23.

Final thoughts
In comparison with other retailers that have been severely affected by economic doldrums, Dillard's reported a far better quarter. Dillard's strategy of closing its under-performing stores along with its plan to not take on short-term debt this year will have positive effects on its operating margin, which will drive its profits upward. Dillard's isn't taking the risk of opening new stores amid economic challenges these days. Instead of investing in new store openings, the company is rewarding its shareholders through stock buybacks and dividends. Financially, the company is sound and it looks to be undervalued at this moment. Considering all of this, I believe Dillard's presents a good investment opportunity at this point in time.

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