After Ascena Retail Group (ASNA) soared 16% last week following a big earnings surprise, I wondered if there was a smaller competitor that had some upside left.
That smaller competitor is Cato (CATO 2.49%), which operates Cato Fashion Stores. I had to drive 100 miles to find one. The store was much the same size as a dressbarn, which is owned by Ascena; it was approximately 4,500 square feet. It also had similar selection: girl's wear, plus size, and missy/junior apparel.
The store was located in a strip mall in a sparsely populated area; 331 persons per square mile in its 41 square mile zip code. Its main competitive advantage was its location 20 miles in any direction from a real shopping mall. Although clean and well stocked, it wasn't busy. Not all Cato stores are located in exurban spots; many are in more bustling suburban areas.
Most of Cato's locations are leased in strip malls anchored by either Wal-Mart or a market-dominant grocer, mainly in the Southeastern US. It vies with Ascena for locations in strip malls with similar anchors.
Cato is a small cap company, one-third the size of Ascena,with a $798.4 million market cap. It operates 1,072 Cato Fashions locations and operates three other retail concepts: It's Fashion and It's Fashion Metro stores, together totaling 213 stores, and 25 higher-end Versona stores, selling ladies apparel and accessories and located in higher-end malls
Cato has had a rough year, with same-store sales down 5% in July. Same store sales did improve in August, only down 2%. Ascena, meanwhile, reported a 4% rise in same-store sales, beat earnings-per-share expectations of $0.20 with earnings of $0.34, and expanded its gross margin by 270 basis points. Cato CEO John Cato wrote in his 2012 letter to shareholders that the company's core customers were affected by payroll taxes, as well as higher food and gas prices. He expects these trends to continue throughout 2013.
When competitor Macy's (M 0.16%) reported second-quarter weakness, especially in junior's and women's apparel, CEO Terry Lundgren attributed it to consumers spending on homes and cars. This was echoed by Ascena CEO David Jaffe on the company's fourth-quarter conference call when he called for conservative guidance.
Macy's has the advantage of being America's largest department store chain. It also owns higher-end Bloomingdale's for a combined total of 852 stores. It offers a 2.3% dividend, which has risen 60.35% over the last three years. Although that second quarter was weak, it looks on track to beat last year's revenue of $27.06 billion and earnings per share of $3.23.
The trailing EBITD margin of 13.30% is almost twice the industry average of 7.20%. Macy's trailing price to free cash flow is 6.80 compared to the industry's 13.30. Macy's price to sales is a low .58.
Location, location, location
John Cato also wrote in that same letter to shareholders that the company was rethinking its real estate strategy, and that should be heartening to would-be investors. The company is opening 65 new stores, closing 15, and relocating another 15.
More encouraging for investors was that the company exited 2012 with $190 million in cash. It is also shareholder friendly, raising its dividend by 20% in February, now at a yield of 0.7%, and with 200 million shares left in its repurchase program. The company is just this year bringing all its e-commerce in-house to help raise margins.
Nonetheless, a caveat for Cato is that CEO John Cato owns 39% of the common share voting rights, and this is listed as a risk factor in the 10-K filing.But if you're a glass-half-full person, it can mean he is very aligned with shareholder interests and the company's success.
Its bigger rival
The retail environment is very competitive, and the 10-K notes that Cato's larger competitors can afford to be more promotional. It has plenty of competitors besides Macy's and Ascena, including off-price retailers like Ross Stores and TJX, as well as Kohl's, Gap, and mall specialty retailers like Chico's and Ann.
Ascena, despite several disappointing quarters partly due to acquisition costs for Lane Bryant and Catherines, has greater exposure to the plus-size market with these two already-accretive brands. Catherines and Lane Bryant are its full-figure focus stores, with more than 1,200 stores between them. The plus size $17.5 billion US market is one of the fastest-growing markets in fashion retail.
Its other 2,600 stores located in the US, Canada, and Puerto Rico are comprised of the brands dressbarn, Maurice's (young women 17-34), and Justice, its tween-targeted brand. And e-commerce sales grew 30% in the fourth quarter.
Of note, dressbarn, the brand most like Cato Fashions stores, reported flat comparable-same store sales, although the brand reported 54% sales growth from e-commerce.. And going forward, Ascena is only opening 55 to 75 stores total across its brands this year, meaning Cato is expanding proportionally almost twice as fast.
Cato vs. Ascena
Cato is more reasonably valued at a trailing earnings multiple of 14.0 compared to Ascena's 21.0, but the price-to-sales ratio is lower at Ascena at 0.7, compared to 0.9 for Cato. What really decides it is Cato's $8.56 cash per share as well as a small yield and no debt. Ascena has some debt, only $1.31 cash per share, and no yield.
A would-be investor might think twice about Cato to see one of these Cato stores in such isolated locations. But upon investigating further, its future looks promising. The company is rethinking its real estate strategy, expanding more quickly, bringing e-commerce in-house, and closing under-performing stores.
All these companies have admitted it's a tough retail environment. But longer term, this under-covered small-cap retailer with a decent yield could soon become a mid-cap with momentum.
