Summary
- I received an inquiry from a reader that asked me to take a look at their favorite department store, due to wanting to invest their pension in the stock.
- I'm happy to take a look and deconstruct the business, even more so when it's a business i was somewhat unfamiliar with prior to my research.
- I'd heard of and visited Dillard's before due to my former partner - it's her favorite store - but i hadn't looked at its financials.
- Here we are, and I'm initiating coverage on this company.
Dear readers/subscribers,
Fashion and clothing are very tricky industries. I once invested heavily in the Swedish retailer Hennes & Mauritz ( HNNMY ) but managed to escape the investment at a profit despite investing at far too high a valuation. It's an ever-changing industry which I view as very difficult to invest successfully in - especially as a shareholder. There are subsets of the industry I like more than others, such as footwear.
Clothing isn't uninvestable - just difficult. Let's see what we have here and look closer at Dillard's.
Dillard's - What the company is & does
The company known as Dillard's ( DDS ) is a clothing and fashion accessories store, marketing its products primarily (60%+) towards women. Their target market is Middle and upper-middle-class women in the US because their stores are found in the US alone.
The company targets, therefore, customers with disposable income to invest in/purchase higher-priced upscale, private-label clothing as well as cosmetics.
The company owns 285 locations and has a history going back nearly 85 years. Most of the stores are found in Texas and Florida but have very little or no representation/locations in the Northeast, most of the upper Midwest, and most of California.
Dillard's operates two types of stores. The typical Dillard's store is between 100,000-200,000 square feet, with many of its flagship stores above 200,000. These are concentrated in the aforementioned Florida and Texas, with more or less the entire southern half of the country having strong representation from the business. These stores are always found in higher-income areas or areas where shoppers with disposable income frequent. The stores are located in shopping malls and open-air centers, as well as having an online outlet.
Dillard's then has clearance stores/centers , which are stores that specialize in selling prior-season merchandise, typically located in lower-income areas. The clothing here is shipped from Dillard's "standard" stores, marked down 60% in price, to the clearance stores where it is then marked down even further in order to facilitate liquidation. The competition in price and target audience would be TJ Maxx or Marshalls. The one difference is that their clearance stores sell only items sent from standard Dillard's department stores.
Looking through the selection, the typical item at Dillard's seems to be priced at about 2-4x of a "normal" item in other department stores or outlets. However, some items can easily breach the $1,000-$1,500 mark, making the company potentially high-end.
I myself source my casual business/formal clothing from a variety of tailors and specialized retailers and tailors across Europe, chiefly Italy, Belgium, and France, and the items found here in Dillard's are more or less similar to the pricing level I typically go for - though "quality" men's fashion tends towards a somewhat higher price level, in my experience. The point is, this is a segment I'm at least somewhat familiar with - even though for instance, I would not buy a Suit or a blazer/sportscoat at Dillard's.
I also don't want to give the impression that Dillard's is just "Lady's" things. This is a store that has around 50-60% female exposure, assuming that the lion's share of cosmetics goes to women, but it has a double-digit sales revenue exposure to both children and 20% to men's apparel and accessories. It's also 15% shoes. The company also has a small Home/Furniture and a Construction segment, with the following formal net sales split.
The sales argument for Dillard's comes to higher-end and exclusivity. It doesn't have the sort of "standard" selection but instead focuses on exclusive brand merchandise like Antonio Melani, Gianni Bini, GB, Daniel Cremieux, and others. These aren't ultra-high-end. We're not talking Brunello Cucinelli, Brioni or Moncler - but respectable products all the same.
The company has numerous flaws from an investment standpoint. The company's yield is lower than 1%, it's BB-rated meaning it has no investment grade, and the past few years have been extremely volatile, with 2021 seeing negative EPS of $3.6 on an adjusted basis, and up to no less than $42.6/share for the expected 2023E period.
Dillard's does not lease its real estate, typically, but owns its stores entirely. Out of 280 stores, only around 30 are partially leased in terms of store, land or a combination of the two.
The company distributes products through several distribution centers, most of them found in Arkansas, Texas, or one of the other southern states.
Dillard's has significantly outperformed the S&P500, not to mention its peer averages for the past few months and years, with most of that outperformance being due to recent trends.
By that, I mean share price trends, not necessarily fundamentals. The way EPS is moving on an adjusted basis, you'd expect massive outperformance, but this is not the case. Total Retail sales increased 8% YoY for 9M22, with comparable store sales up 8% and net income up double digits as well. For 3Q22 YoY, the results were far more modest, with sales increases of 2-3% with strength in men's apparel, accessories, and basically non-core (female products) lines.
At the same time, SG&A and Operating expenses are climbing. Retail OpEx is up to 27.5% of sales, up around 80 bps mostly due to inflation and payroll expenses and a very competitive wage environment.
The reason for the way that this chart looks...
Dillards valuation (F.A.S.T graphs)
... is essentially a massive short-squeeze and share buybacks up the wazoo. This can really throw some investors off a loop here if you don't understand it, so let me quickly break it down. What has happened is this.
Dillard's SO (TIKR.com)
Dillard's essentially reached Meme-stock status back in 2021, which tends to color things somewhat. It's an absolute mess of a chart, which makes any sort of analysis harder, with some analysts even comparing it to Gamestop (GME).
That's obviously not where I am, or "go in" to an investment, and that makes investing in Dillard's at this time very complex.
I like the business model - in order to differentiate yourself in this space, you need exclusive brands and a sales argument. Dillard's has that. The stuff you buy here, you can't get anywhere else - they're exclusive (some of them). That's what you want, and that's why I don't invest in a whole lot of other retailers that essentially sell the products from other companies, which can be sold by anyone with deep enough pockets.
In my approach, I try to stick with companies as close to the "basics" as possible, meaning I don't buy a whole lot of companies that essentially just act as retailers, but either own their own production or have some sort of exclusive advantage. Because if the only thing you do is sell what others are doing, and there's no real moat, chances are that you will eventually be replaced.
So, Dillard's has at least some advantages there, even if far from everything they offer is exclusive.
The thing is though, Dillard's isn't really different or good enough to its peers to command the sort of trend that it's currently getting from the market. What's more, the current estimates are for 2023E to be relatively flat (less than 6% annual growth compared to 1,200% in the year before), before seeing its GAAP earnings drop going into 2024-2025E Fiscals.
And this trend is forecasted by most industry professionals, analysts, and investors following the stock. I concur with this assessment, for the following reasons:
- Cost increases are unlikely to go away - inflation and wage stress are here to stay for a while.
- The economic macro compression is likely to strain even Dillard's typical target audience - we've already seen that growth in the core segment of ladies' clothes, cosmetics, and accessories has slowed down or even stalled. This might continue or even reverse.
- The fact that fashion/this sort of investing in discretionary companies is one of the riskier plays out there in cyclical sectors. For most of the past 20 years, the company hasn't actually outperformed indices.
So, Dillard's isn't really a "bad business". But it's tricky for the same reasons that other fashion and discretionary plays in the subsector are. Most importantly, it's not "different enough" or with a big enough moat here to make me interested.
Let's look at valuation quickly here.
Dillard's Valuation
As I showed you, Dillard's valuation is a very tricky prospect. It's arguably in a short-squeeze, gone meme-stock territory, combined with lowering the SO by more than 60% over the past 10 years. This requires a lot of adjusting and even once done, it's not all that easy to decipher what might be an attractive valuation.
So, Dillard's is considered overvalued today, first of all, by most analysts that follow the stock. The company has a massive range, starting at $150 and going to $380. 3 analysts follow the company, meaning I expect they can barely agree on if something is "up" or "down". The average comes to around $294, which is almost 9% lower than the current share price.
Dillard's trades in a peer group that contains companies like Target ( TGT ), Dollar General ( DG ), Macy's ( M ), Kohl's ( KSS ), Nordstrom ( JWN ), and similar companies. What's more, the company isn't really undervalued to any or most of these businesses from any perspective that I consider to matter. Revenue multiples, EBITDA, P/E, FCF - in almost all of these multiples, several of these aforementioned peers are significantly better valued. This implies, or would imply, that instead of DDS, we should be looking at them, provided that they're "safe businesses".
To be frank with you, I think Macy's looks a lot more interesting here because it hasn't been through meme-mania, and doesn't trade at any sort of elevated normalized share prices - in fact, from most multiples, it's half the price of Dillard's.
However, when you have a scenario where a company is more expensive than its peers and according to most is overvalued here, what you need to ask yourself is if there is any particular reason why Dillard's should be allowed significantly higher premiums than any of these other stocks, or why we should allow for the stock to trade significantly higher.
That's where exclusivity could come in as an argument, management quality, or dividends, or credit rating. Unfortunately, DDS doesn't really have a superb advantage in any of these. BB- credit, no yield to speak of, and capable, but certainly not class-breaking management.
I've looked, and I can't find a reason for Dillard's to be allowed an outsized premium. The company is too risky - in fact, I find the entire sector to be a risky investment , but Dillard's doesn't separate itself from the masses in any positive or altering way. Forecasts are for earnings compression and price/cost increases combined with people facing a grim near-term future, impacting disposable income and discretionary spending.
I will be interested in following Dillard's and other department stores and clothes boutiques to see how they navigate the coming few years. I certainly ask my tailor/s when I'm fitting a new piece or having something adjusted how things are going - but those are of course two very different worlds.
My point is, I'm fine watching and observing - analyzing - but I would not want to be investing in these companies right now, unless at severely discounted pennies on the dollar, and with a good upside. Some of these companies have that. Dillard's, as I see it, isn't one.
PT initially will be below $200/share here, and my stance for my reader who asked me about her pension money because she loves Dillard's is the following - Buy the merchandise if you like - it seems like good-quality stuff - but avoid the stock here.
The Thesis for Dillard's is the following.
Thesis
- Dillard's is a difficult play to work with, given the risks inherent to the company in the form of increased expenses, and the overall risks to any department or cyclical clothing store. Differentiation is key here - or being able to buy at pennies on the dollar.
- I don't see enough of either of these things to make me interested at this particular time.
- For that reason, this one is a "HOLD" - though if I held it, I might consider rotating my holding here.
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them ( italicized ).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
The company fulfills only 2 of my criteria, and the "quality" argument can even be argued here. There is no doubt to me that this one is currently a "HOLD".
For further details see:
Dillard's: Why This One Is 'Hands Off'