The U.S. hasn't quite emerged from the COVID-19 pandemic yet -- but don't tell Dillard's (DDS 1.16%) that. On Thursday, the regional department store operator posted solid sales and record earnings results for the first quarter of fiscal 2021, smashing analysts' estimates.
Dillard's stock responded by surging 23% on Friday. Let's take a look at the company's surprising quarterly performance and what it means for investors going forward.
Dillard's stock performance, data by YCharts.
A blowout earnings report
Last quarter, Dillard's continued its post-pandemic recovery. Total retail sales surged 73% year over year to $1.3 billion, as the retailer recovered a lot of the ground it lost a year ago, when the pandemic forced many stores to close and crushed traffic to those that remained open.
Dillard's didn't quite reach the $1.42 billion retail sales volume it managed in the first quarter of 2019. However, sales momentum has accelerated since February. (Indeed, seasonally adjusted sales for department stores jumped 12.6% in March compared to February, before easing slightly in April, according to Census Bureau statistics.) For the latter part of the quarter, Dillard's was exceeding 2019 sales levels.
Even more impressively, Dillard's earnings soared to a quarterly record of $158 million ($7.25 per share). Excluding $0.88 per share of asset sale gains from selling three stores, Dillard's recorded adjusted EPS of $6.37. That was four times the average analyst estimate of $1.54 and more than double the company's earnings in the first quarter of 2019.
A stellar gross margin performance helped drive this earnings beat. Retail gross margin surged to 42.7%, as tight inventory management and strong pent-up demand enabled Dillard's to cut back dramatically on discounting. This easily beat the Q1 2019 figure of 37.8%, let alone the awful mark of 12.8% recorded during the depths of the pandemic a year ago.
Image source: Author.
Lastly, Dillard's managed to maintain a lot of the cost savings it achieved last year, even as sales bounced back. Retail operating expenses were down 17% from the first quarter of 2019.
Excellent cash flow, too
Historically, Dillard's hasn't generated much cash flow in the first quarter, but operating cash flow reached $302 million last quarter. Meanwhile, the company continued to keep capital spending at a very low level, with quarterly capex of just $17 million.
Thus, Dillard's generated $285 million of free cash flow last quarter alone: a substantial sum, considering that the company carries a market cap of less than $3 billion. Dillard's also received $29 million of asset sale proceeds last quarter. This enabled it to buy back $55 million of stock during Q1 while still fortifying its balance sheet. In fact, the retailer now has more cash than debt.
Unsustainable profits
So should investors rush out to buy Dillard's stock after its incredible first-quarter earnings report? Probably not. U.S. consumers have approximately $2.6 trillion of excess savings right now, which is buoying spending -- and potentially making shoppers less price sensitive. The resulting sugar rush for retail sales could last for a year or two, but it won't go on forever.
Image source: Getty Images.
Looking ahead, Dillard's will face stiff competition from rival department stores and other retailers, just as it did before the pandemic. Even with good inventory management practices, it will need to offer more discounts to drive sales, pinching margins. Furthermore, Dillard's skimpy capital spending will make it hard to attract younger customers. (For example, it has no mobile app.)
So while Dillard's is on track to earn huge profits in 2021, profitability is likely to subside over the next few years. In the long run, as its customer base ages while trendier retailers add stores and expand their e-commerce businesses, Dillard's could face severe pressure on sales (which will in turn reduce its earnings).
A year ago, Dillard's stock was trading for less than $30 and at a steep discount to book value. At that valuation, there was enough upside to justify the risk of owning the stock. Since then, Dillard's shares have more than quintupled to trade at a big premium to book value. Between its increased valuation and the future threats to its business, Dillard's doesn't look like an attractive stock for long-term investors today.
