Why Dillard's Latest Recovery Isn't Here to Stay

Like its larger peers Macy's and Kohl's, Dillard's (DDS 2.14%) experienced a rebound in sales and earnings growth beginning in late 2017. Comps rose 3% in the fourth quarter of fiscal 2017 and 2% the next quarter.

In this Industry Focus video, the cast discusses the sustainability of this turnaround. Dillard's has spent the vast majority of its cash flow on share buybacks in recent years rather than investing in technology, fulfillment, and store upgrades. This leaves it vulnerable during the next retail downturn.

A full transcript follows the video.

This video was recorded on June 12, 2018.

Vincent Shen: Any specific initiatives that you wanted to call out that management has been really focused on recently?

Adam Levine-Weinberg: Dillard's is a bit of an enigma. The company is still largely owned by the founding family, the Dillard family. They hold all of the senior management roles at the company other than CFO. They don't hold earnings calls, they don't have investor conferences or presentations. They basically don't tell investors anything other than the quarterly reports that they're required to file, so it's a little hard to understand what they're doing.

When you read through a quarterly earnings release for Dillard's, it doesn't talk a lot about initiatives that they're doing to try to drive traffic. If you dig deeper and look at their financials, this is a company that's really, seriously, over the past decade, cut back on their capital spending. Whereas Kohl's and Macy's are spending about $700 million and $1 billion, respectively, each year on capex, with a lot of that money going toward technology, Dillard's is spending between $100 and $150 million a year.

Now, to be fair, they do have a smaller store network, so that does cut down on the cost they need for reinvestment. That said, with a lot of these technology investments, there's not much change in what it costs to build out the same capabilities, just based on what your scale is. Other smaller retailers that are really tech-forward are spending just as much money as Kohl's and Macy's to build out their technology capabilities. Dillard's really just seems to be conserving cash to maximize their free cash flow, and then, with the free cash flow, management has just been buying back a huge amount of stock.

So with Dillard's, it really seems like the company is hoping for a broad revival in retail sales and improving mall traffic to lift the business, and the company is not really investing a lot of money in self-help initiatives to try to fix its problems. Just digging into the first quarter numbers, it seemed like inventory was growing at a faster rate than sales, which is a little bit disconcerting, because that often will put pressure on profit margins going forward. Also, the 2% comp sales increase that Dillard's reported was slower than what you saw at Kohl's and Macy's, even though Kohl's and Macy's have more of a presence in the Northeast and Midwest, where there are these really bad snowstorms that probably hurt traffic and sales of spring apparel. Meanwhile, Dillard's is almost all in the South, in that Sunbelt region, so that should have boosted Dillard's comp sales results last quarter, and it really didn't seem to help very much.

It's a little troubling, what you're seeing at Dillard's right now. It's not clear that the company really has a strategy to make a sustainable turnaround. Look, if the market does great, the fact that they're buying back so much stock will lift the stock price simply because even if the net income is flat, that's a big boost to earnings per share. The problem is that, you saw a big increase in Dillard's stock price a few years ago through this strategy, and then, beginning around 2015, profit margins deteriorated very rapidly, and the bottom fell out from under Dillard's stock. There's really a risk that that's going to happen again whenever the next retail downturn happens, and that could only be a year or two away, for all we know.