Off-Price Still Offers Value for Investors

Most people think of TJ Maxx and Ross Stores when investing in the off-price space, but there's an overlooked gem.

Apr 28, 2014 at 2:33PM

Many of the off-price retailers held up nicely throughout the economic downturn. Shares of TJX (NYSE:TJX), Ross Stores (NASDAQ:ROST), and Dillard's (NYSE:DDS) are all up over 90% over the last three years, while the S&P 500 index is up only 40%. The reason for this is that these retailers offer a wide array of products, from apparel to home goods, at attractive prices. Thus, many shoppers have been trading down from higher-end department stores in an effort to save money. But will that be enough to keep shoppers coming back as the economy rebounds?

The best way to play off-price retail
What looks to be one of the best-in-show department-store retailers is Dillard's. This retailer doesn't rely as heavily on the lower-income market as TJX and Ross. Thus, Dillard's products should continue selling nicely during a rebounding economy.

Dillard's was a turnaround story back in 2006. One of the key lessons it learned was to keep a "fresh" merchandise mix. If a brand is underperforming, Dillard's eliminates this brand and quickly replaces it. Dillard's has also added exclusive brands, including Antonio Melani, Gianni Bini, and Roundtree & Yorke.

Dillard's is already preparing for the rebounding economy. It's been looking to distinguish itself from the lower-tier department stores by branding itself as a mid-tier department-store retailer, hence its introduction of exclusive brands. This helps it avoid having to heavily discount its merchandise. This should also help Dillard's keep its margins higher than its peers. Dillard's already has one of the top net profit margins in the industry at 13.6% (over the trailing-12 months), compared to TJX's net margin of 7.9% and Kohl's 4.8%.

Dillard's remains underrated
With fewer than 300 stores, Dillard's also has the potential to expand its footprint, namely in the Western part of the U.S. TJX rules the off-price sector, generating more revenue than any of its peers. Its store base is also fairly vast, with more than 1,000 TJ Maxx stores, 900 Marshalls stores, and 450 HomeGoods stores. Ross Stores operates some 1,200 stores in 33 states.

Even with more than 1,000 stores, Ross Stores remains at a big disadvantage given it's the only key off-price retailer without an e-commerce platform. And TJX has another advantage given it operates various brands across the U.S. and Europe.

Dillard's also remains an underfollowed investment. There are only six analysts following Dillard's, compared to the 25 following TJX, 25 following Ross, 17 following Macy's, and 22 following Nordstrom.

How shares stack up
Despite the strong fourth quarters for both Ross Stores and TJX, shares of both are down more than 5% year to date. Meanwhile, Dillard's shares are flat. Dillard's trades at a 10.7 P/E based on next year's estimates. That's much lower than either Ross Stores or TJX, which trade at 14.8 and 16.5, respectively.

And when you factor in expected earnings growth, Dillard's is an even more enticing investment. From a P/E-to-growth (PEG) ratio standpoint, Dillard's ratio is 0.7 compared to Ross Stores' 1.4 and TJX's 1.7. The story for Dillard's is pretty exciting, where its return on investment is near decade highs as well as its net profit margin. Dillard's inventory turnover ratio is also at the highest rate ever.

Dillard's also recently initiated a dividend payment. At year-end 2013, Dillard's announced a cash dividend of $0.06 per share. This should be a great way for Dillard's to put its cash flow-generating capabilities to work. Its dividend yield is only 0.2%, but Dillard's has managed to reduce shares outstanding by 33% over the last three years ending fiscal 2013.

Bottom line
Dillard's is the smallest of the off-price operators, but it looks to be the best investment in the space. It has the opportunity to expand within the U.S. while also enjoying industry-leading margins. For investors looking to play the off-price retail market, Dillard's is worth a look.

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool owns shares of Dillard's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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