Department store Dillard's (NYSE:DDS) unexpectedly released earnings around noon last Saturday. It was unorthodox timing for a conventional store -- too conventional, perhaps, to compete with trendier rivals.
Sales for the first quarter were basically flat at $1.84 billion, versus the $1.8 billion reported in 2005. Net income rose an impressive 67% to $0.77 per diluted share, well ahead of consensus estimates of $0.56. Same-store sales were up 2%, inventories fell, and the gross margin improved 70 basis points sequentially because of a higher-margin merchandise mix.
Over the last five years, sales growth at Dillard's has been weak, averaging a negative 3%, while earnings have grown just less than 7%. The debt-to-capital ratio is reasonable at 32%, but net margins are quite low, averaging a paltry 1.1% over the last five years, and have decreased along with comparable sales. This has contributed to a meager average 3.8% return on equity and a scant 1.7% return on capital.
So what's to like? The retailer's stores throw off huge amounts of cash flow from operations, to the tune of three to four times net income over the last two fiscal years. Unfortunately, most of it goes to capital spending to remodel huge, older stores that are clearly costly to renovate, perhaps demonstrating how far Dillard's has fallen behind competitors.
In Dillard's defense, it has assembled a string of decent quarters. Things could finally be taking a turn for the better, especially if the company can continue cost-cutting moves and further enhance margins and profitability. Brokerage firms applaud its results over the last few quarters, but the lackluster track record has resulted in neutral ratings and one underperform rating. The Street believes there are more compelling opportunities in the old-line retailer space, such as the Federated/May (NYSE:FD) combination, which offers greater merger synergies and better opportunities to cut costs.
Dillard's could be sold to or merge with another department store, but there are few strategic suitors. J.C. Penney (NYSE:JCP) is one of the few remaining independents, and it's doing a good job of going it alone. Plus, a sale would have to be approved by the Dillard family, which controls two-thirds of the board of directors. On the flip side, a sale or merger would be easily approved if the family decided to pursue that tactic, perhaps to a private equity group.
Overall, it appears that investors stand a better chance of outperformance in the newer breed of mass merchandisers, such as Target (NYSE:TGT), Wal-Mart (NYSE:WMT), and Kohl's (NYSE:KSS). These firms have much better track records and growth prospects, making any potential upside in Dillard's much less compelling.
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Fool contributor Ryan Fuhrmann has no financial interest in any shares mentioned. Feel free to email him with feedback or to discuss the company further.
