Most investors avoid department store stocks like the plague. Department stores have been losing market share to discounters, specialty retailers, and e-commerce companies for decades. Just in the past five years, many prominent department store chains have filed for bankruptcy or gone out of business entirely, including Sears, J.C. Penney, Neiman Marcus, Lord & Taylor, and Barneys New York.
Yet one department store company has delivered market-crushing returns in recent years: Dillard's (DDS 0.80%). Since bottoming out during the Great Recession, the stock has been a 132-bagger on a total return basis. Remarkably, Dillard's has delivered these incredible returns without growing its top line at all.
Doing the same with less
On March 5, 2009 -- the same day that Dillard's stock bottomed out -- the company reported an adjusted net loss of over $100 million for fiscal 2008. Merchandise sales totaled $6.74 billion for the year: down by 6% from fiscal 2007.
A few months ago, Dillard's reported that merchandise sales reached $6.7 billion in fiscal 2022, roughly in line with 2008 levels. But whereas Dillard's reported a big loss in 2008 -- and was barely profitable in 2007, despite posting higher sales -- the company generated an incredible $845 million adjusted net profit last year.
Obviously, favorable macroeconomic conditions last year compared to the weak economy of 2008 supported the sharp improvement in profitability. But two "self-help" initiatives arguably played an even bigger role.
Image source: Author.
First, Dillard's has become much more careful about inventory management. The retailer entered fiscal 2008 with $1.78 billion of inventory, but began fiscal 2022 with just $1.08 billion of inventory: a 39% reduction. In 2008, massive clearance markdowns to move slow-selling merchandise pushed gross margin below 30%. By contrast, gross margin has exceeded 40% for each of the past two years, helped by Dillard's lean inventory management.
Second, Dillard's has aggressively cut costs. Indeed, it has been willing to leave some revenue on the table to keep costs down. For example, several years ago, it reduced its store operating hours. Rather than being open from 10 a.m. until 9 p.m., the stores are now open from 11 a.m. to 8 p.m. That has reduced labor costs and complexity, as most employees now have a full-day shift. As a result, selling, general, and administrative expenses totaled $1.67 billion last year: down from $1.93 billion in fiscal 2008.
Returning cash to shareholders
Dillard's profitability improvement didn't occur steadily over time. The company significantly improved its margins in the first few years after the Great Recession, but then it experienced a period of margin compression and falling earnings beginning around 2015. Profitability then surged to new highs beginning in 2021.
Due to this earnings volatility, Dillard's stock has frequently traded at a depressed valuation relative to its earnings and cash flow. Management has capitalized on the volatile share price through an aggressive share repurchase program. Dillard's has reduced its share count by 78% since early 2009, giving EPS (and the share price) a big boost.
Dillard's Total Return, Shares Outstanding, and Operating Income, 2009 to present: data by YCharts.
And while Dillard's regular dividend is very modest, the company has recently begun to return some excess cash to shareholders through special dividends. The company paid special dividends of $15 per share in late 2021 and again in late 2022, adding to shareholders' total returns.
Multiple paths to stock market success
Companies with consistently strong revenue growth often deliver big gains for shareholders. But those stocks typically trade at a premium, and any slowdown in growth can lead to steep share-price declines.
Dillard's performance since 2009 shows that companies with margin expansion potential can also offer phenomenal upside, even without revenue growth. That's particularly true when the market remains skeptical of the turnaround for a long time, as it allows the company to rapidly reduce its share count to boost future EPS growth.
Going forward, Dillard's may struggle to continue beating the market. However, investors who can find the next company with significant margin expansion potential and a beaten-down share price could earn spectacular returns.
