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Retail stocks are up 6% since August 1 – but these 2 stocks are REALLY bad bets

Retail stocks are up 6% since August 1 – but these 2 stocks are REALLY bad bets

Perhaps it’s an indication of over-exuberance that the market has lately seemed to just shrug off the latest global trade news. It could also be that investors have come to accept tariff threats and trade tensions as “the new normal.” Either way, it is interesting that while the Trump administration imposed a new set of tariffs on China, the market today decided to use the fact that the tariffs were set at a lower-than-expected 10% instead of the 25% that many had feared as a catalyst to drive higher. Among the industries that have been responding favorably since the beginning of August is the retail industry, driven in large part by stocks like KR, TGT and KSS that have only dropped from 52-week highs in the last week or so. Even with the most recent pullback, the industry is up 6% since August 1, as measured by the SPDR S&P Retail ETF (XRT).

There are a lot of different, recognizable names in the department store space, companies that have been around for decades and that have weathered one economic cycle after another. Not all department stores are seemingly on the brink of going out of business like Sears Holdings (SHLD) or J.C. Penney (JCP); in fact the two stocks that I’m writing about today have some important strengths about their businesses, like conservative debt levels by most measures, healthy Return on Equity (ROE) and Return on Assets (ROA) and recent improvements in revenues and earnings. So why do I think investing in these stocks is such a bad idea right now?



Another interesting fact is that the answer to that question is different for each stock. The first stock, Dillards Inc. (DDS), has what appears to be, by most standard value-oriented measurements, a really attractive value proposition; but digging into some of their fundamental information reveals some additional trends that actually turn that apparent bargain-buying opportunity into what I like to call a “value trap” – a stock that is trading at discounted levels because there are good reasons beyond the mere possibility that the market doesn’t like the stock right now. In the second case, Nordstrom Inc. (JWN) has fundamentals that generally look very positive; but running a simple value-based analysis shows the stock is significantly overvalued right now. 

One characteristic of both companies, and that I think adds to their overall risk profile, is that like many retail stocks, they operate with extremely narrow margins profiles. That gives management very little financial flexibility, which means they may have less ability to take advantage of new opportunities in the marketplace as they arise, and could face tougher challenges than other companies if the current, ongoing long-term trend of economic strength shifts and starts to go back down again. Consider also that both of these stocks rely heavily on foot traffic at shopping malls, where their stores act as centerpiece attractions. Consumer preferences and trends have been clearly moving away from the decades-old idea of traditional shopping and to trendier, smaller specialty shops or to online retailers. That has been, and is likely to remain an ongoing challenge that both DDS and JWN will continue to grapple with.



Dillards, Inc. (DDS)

Current Price: $78.33

Dillard’s, Inc. is a retailer of fashion apparel, cosmetics and home furnishing. As of January 28, 2017, the Company operated 293 Dillard’s stores, including 25 clearance centers, and an Internet store offering a selection of merchandise, including fashion apparel for women, men and children, accessories, cosmetics, home furnishings and other consumer goods. The Company’s segments include the Retail operations segment and the Construction segment. The Retail operations segment includes the operation of the Company’s retail department stores. The Construction segment includes the operations of CDI Contractors, LLC (CDI), a general contracting construction company. CDI’s business includes constructing and remodeling stores for the Company. As of January 28, 2017, the Company operated retail department stores in 29 states, primarily in the southwest, southeast and midwest regions of the United States.. DDS’s current market cap is $1.8 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings increased by almost 83% while revenues posted an increase of only 2.5%. In the last quarter, earnings reversed, declining more than 103%, while revenues were only about .5% higher. The company operates with a very narrow margin profile, with Net Income running at only about 2.8% of Revenues for the last twelve months, and that actually turned negative in the last quarter.
  • Free Cash Flow: DDS’s free cash flow is modest, at only about $96 million. This number has declined since the first quarter of 2017, when it was a little more than $450 million.
  • Debt to Equity: DDS has a debt/equity ratio of .34, which in and of itself is a conservative number that most investors will take as a positive. Also working in the company’s favor is the fact that since the last quarter of 2016, DDS’s long-term debt declined from more than $800 million to a little over $565 million; however the steep decline in Free Cash Flow, the fact that Net Income in the last quarter turned negative along with the severe narrowing of an already thin operating margin implies the company is in a precarious state where liquidity is concerned. They have almost no flexibility to do much more than try to keep the status quo right now, and doing even that much could be a challenge.
  • Dividend: DDS pays an annual dividend of $.40 per share, which translates to an annual yield of about .5% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for DDS is $60.67 per share and translates to a Price/Book ratio of 1.29 at the stock’s current price. This is where you might be tempted to buy into the idea that the stock is cheap right now: their historical average Price/Book ratio is 1.72, which suggests the stock is trading right now at a discount of about 33%, and that puts the stock’s long-term target above $104 per share. The stock last saw movement in that price range in mid-2015.



Nordstrom, Inc. (JWN)

Current Price: $64.06

Nordstrom, Inc. is a fashion specialty retailer in the United States. The Company’s segments include Retail and Credit. As of March 20, 2017, the Company operated 344 the United States stores located in 40 states as well as an e-commerce business. The Company also offers its customers a variety of payment products and services, including credit and debit cards. As of March 20, 2017, the Retail segment included its 117 Nordstrom-branded full-line stores in the United States and Nordstrom.com, 216 off-price Nordstrom Rack stores, five Canada full-line stores, Nordstromrack.com/HauteLook, seven Trunk Club clubhouses and TrunkClub.com, two Jeffrey boutiques and two clearance stores that operate under the name Last Chance. The Company, through Credit segment, allows its customers to access a range of payment products and services, including a Nordstrom-branded private label card, approximately two Nordstrom-branded Visa credit cards and a debit card for Nordstrom purchases.

  • Earnings and Sales Growth: Over the last twelve months, earnings increased by more than 46% while revenues posted an increase of 7.2%. In the last quarter, earnings increased even faster, at more than 86%, while revenues increased a little over 14%. Like DDS, the company operates with a very narrow margin profile, with Net Income running at about 3.2% of Revenues for the last twelve months, and increased modestly to 3.9% in the last quarter.
  • Free Cash Flow: DDS’s free cash flow is healthy, at a little more than $760 million. This number has held pretty steady since the last quarter of 2016..
  • Debt to Equity: DDS has a debt/equity ratio of 2.35, which is higher than normal and usually suggests the company is highly leveraged; in JWN’s case, this isn’t too much of a concern, since the company has more than $1.3 billion in cash and liquid assets, suggesting that if operating profits aren’t sufficient to service debt, they have good liquidity to make up the difference.
  • Dividend: DDS pays an annual dividend of $1.48 per share, which translates to an annual yield of about 2.3% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for DDS is $6.76 per share and translates to a Price/Book ratio of 9.47 at the stock’s current price. This is a very high ratio, which is troubling by itself; but that concern is compounded by the reality that their historical Price/Book ratio is on.y 7.6. That puts the stock’s long-term target price nearly 20% below its current price, at about $51 per share.

JWN and DDS are competing stocks at opposite ends of the fundamental and value spectrum. DDS has a very interesting case for being deeply discounted, but with critical fundamental reasons that suggest even worse could be in store. JWN has a very solid fundamental base to work from, but a value proposition that suggests the risk: reward ratio is tilted too far to the negative to justify taking a position. The best move with these stocks? Leave them behind for now, and come back to check on them again in a few quarters to see if circumstances have changed.


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