Dillard's Not On My Shopping List This Holiday Season, But Remains Investment-Grade

seekingalpha11-19

Dillard's gets downgraded to a neutral/hold rating from my prior buy rating, while it also has kept its Fitch BBB- investment-grade rating this year.Lackluster YoY retail sales growth forecasts this ...

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LPETTET  Thesis: Downgrade to Hold/Neutral as Buying Indicators Are Lacking Returning to the theme of holiday season shopping again, it's fitting to do a follow-up on retail brand Dillard's (NYSE:DDS), who just had their quarterly earnings results on Nov. 14th, beating earnings estimates. In my last coverage of this stock a year ago in Oct. 2023, I called it a buy even though the Wall St consensus said sell, and since my bullish call it is up +35%. At the time, I put a lot of weight on the firm's positive cashflow, dividend growth, and revenue growth. Fast-forward to Nov. 2024, and after the recent earnings report and current conditions, I am downgrading this stock one notch to a rating of hold/neutral. On the one hand, this firm has strong profit margin vs. peers, low debt-to-equity vs. peers and an investment-grade (BBB-) rating from Fitch. That's where the positives end for me. The negative factors pulling this stock down from buy territory include the fact that it is now overvalued vs key peers on three metrics (P/E, P/B, EV/EBITDA), there are multiple macro forecasts from external sources showing a mediocre 2-3% annual holiday sales growth this year in retail, Dillard's and several peers show a negative forward revenue growth projection, and a negative EPS growth according to the analyst consensus. In addition, Dillard's has much less retail market share than several key peers like Macy's and Nordstrom, for example, as well as not making much of a dividend case with a dividend yield below 1%, all while being in an industry prone to recessions and pandemics which we have seen can cause a huge business impact. Stock Overview: A Storied American Retailer Now Trailing Behind in Market Share Arkansas-based Dillard's has a storied history, according to its investor website: Dillard's was founded by William T. Dillard in 1938 in Nashville, Arkansas with an $8,000 investment in a hometown department store. Today, Dillard's, Inc. ranks among the nation's largest fashion retailers – operating 273 Dillard's stores including 29 clearance centers spanning 30 states and an Internet store. According to available Statista data for 2023, notable to mention is that among top US department stores for domestic sales (in $B), Dillard's trails behind 4 key retail brands, with Macy's dominating the top spot, which I think provides some insight into this company's market share but also the stiff competition it faces. Dillards - US market share vs peers (Statista) The peer comparables I selected for today's research are four major retailers trading on US exchanges, that have strong brand presence across American malls nationwide but also have a strong e-commerce presence as well: Nordstrom (JWN), Macy's (M), Kohl's (KSS), and The Gap (GAP). Another honorable mention in this peer group is Neiman Marcus, and its sister brand Bergdorf Goodman, upmarket brands who are privately held and not publicly traded, so not included in my comparables, but nevertheless provide competition to Dillard's. In addition, JC Penney was taken private some years ago, and as the table above shows it also has a bigger market share than Dillard's, however it also does not necessarily cater to some of the higher-end shopping categories that Dillard's and Nordstrom might. Earnings View: Top-Line Will Face Growth Struggles Although the stock beat earnings estimates, its recent Q3 results were not stellar. As its Q3 release shows, total retail sales declined 4% YoY, comparable store sales declined 4%, and EPS fell to $7.73 vs $9.49. Although the earnings release did not seem to mention any full-year earnings outlook, the CEO commented on the firm's focus towards expense control and expanding gross margin, while further commentary pointed to what categories were stronger and weaker: Cosmetics was the strongest performing merchandise category, with the weakest performances noted in juniors’ and children’s apparel and men’s apparel and accessories. So, to get a sense of what could drive future performance, keep in mind the seasonality of this type of business, which points to the quarters representing the holiday shopping season (late November to New Years) usually generating the most revenue. Evidence of this is seen in the income statement, which shows that in this period shown the firm's top-line revenue had its best quarters ending Feb 2024 and Jan 2023, which would have included sales from the holidays, while revenue declines in the subsequent quarter. Dillards - revenue trends (Seeking Alpha) Knowing this, the next question is, are there any indicators of what this year's holiday shopping season may look like, and what external sources outside the firm are saying. A Nov. 1st article in Forbes cited data from Salesforce (CRM) indicating this year's customer will be increasingly price-conscious: Salesforce's latest Shopping Index reveals a dramatic shift in consumer behavior: two-thirds of global shoppers report that prices will dictate where they choose to shop in 2024, up significantly from 46% of shoppers in 2020. In terms of sales growth vs last year, what the National Retail Federation said in a recent presentation is that they expect \"total retail sales during the holiday months of November and December will grow between 2.5% and 3.5% over 2023 to between $979.5B and $989B.\" From that same presentation, it's worth noting that consumer survey data shows nearly 60% will shop online for holiday purchases, which I think heightens the competition for Dillard's even more since all of its peers I mentioned also have a robust e-commerce presence as well. Shopping Destinations: Online vs Offline (Natl Retail Federation) Supplementing the above evidence is data is from Adobe Analytics, indicating that \"shopping on mobile devices is expected to hit a new milestone, contributing a record $128.1B and growing 12.8% YoY.\" In a nutshell, Dillard's is in an environment where customers are increasingly scrambling online for the best deals, and holiday sales growth for this sector expected to be less than 3% YoY. In fact, global consultancy Bain & Co did a study in September where they forecast just 3% growth this year for US holiday season sales, below the 10-year average of 5.2%. Consider also from the chart below that the post-pandemic shopping boom shown in 2021 seems to have tapered off in subsequent years. It also shows that the major pandemic year of 2020 saw most sales come from online and not physical stores. 2024 holiday outlook (Bain & Co) Getting more granular, within the peer group I selected earlier, SA data shows that all of the peers including Dillard's are expected to have negative forward revenue growth, which I don't think helps the case for this buying stock much. Dillards - fwd rev growth vs peers (SA) The Bottom Line: A Much Stronger Profit Margin than Peers What could help Dillard's somewhat is to beat the competition on profitability, and this will require efficient cost control and reduction, to maximize turning revenues into earnings. One indicator I look at is the net income margin. Here is a comparison of Dillard's profit margin vs. peers: Dillards - profit margin vs peers (SA and author worksheet) What the data tells us is that Dillard's beats this peer average by 150% when it comes to profit margin. Additional profitability data from SA shows that Dillard's also beats its overall sector in profit margin by 115%, which, I think, will put Dillard's in a stronger position to turn that paltry holiday annual sales growth into actual profits when it's all said and done. Debt Risk: Investment-Grade Rating Remains Another bright spot for Dillard's is that it has the lowest debt-to-equity vs this peer group I created, as the chart below shows, and I think it adds confidence to this firm having a lower risk profile when it comes to debt, something I think investors should think about. Data by YCharts To add another layer to the risk discussion, I considered ratings by credit agencies. Notable to mention is that Fitch affirmed its \"BBB-\" grade for Dillard's back in April, with an \"outlook stable\" rating. In its rating commentary, Fitch said that \"Dillard's ratings benefit from its good financial flexibility and limited debt position. The company has a modest debt load of around $420 million.\" Keep in mind that on the Fitch scale, a BBB- grade is on the lower end of what is considered \"investment-grade.\" Dividends: Not the Best Option Among Peers As a dividend-focused investor myself, I'm turning my attention briefly to the dividend yield from Dillard's stock, along with evidence of a return last year to dividend growth in the last few years after hardly any growth before that. When it comes to its yield compared to peers, however, it falls behind enormously with its mediocre yield of 0.23%, while stock in retailers like Kohl's offers a yield past 11% right now. Data by YCharts Further, with near-term revenue growth and EPS growth estimates not stellar, I question the ability of this firm to be able to grow the dividend past $0.25/share, so I am not convinced that this stock is a great dividend play at this time, at this share price and future outlook. Price/Valuation: Trading Above Average & Overvalued vs Peers Trading around $427 as of this article writing as we head into a new trading week in mid-November, what the chart below tells me is that although this stock is far past its lows during the pandemic years when non-essential retail was particularly hit hard, it is still just hugging its 200-day moving average. Data by YCharts In addition, momentum data shows it has mostly underperformed the S&P500 in the 2nd half of this year. However, a key metric I use often to get a sense of valuation is the forward P/E ratio (GAAP-based) as it tells me what kind of premium investors are paying for this stock in relation to future earnings expectations. In this case, using peer data on Seeking Alpha, I created the sheet below which shows Dillards as overvalued by 23% to this peer group's average when it comes to forward price-to-earnings multiples, making it an outlier, even though valuation data on Seeking Alpha may be showing it as undervalued to its overall sector. Dillards - PE ratio vs peers (SA data & author worksheet) I think the above overvaluation vs this peer group is not justified considering the analyst consensus calls for declines in YoY EPS growth in the next two fiscal years, and there has only been 1 upward analyst revision. Because of this discrepancy, I think we need additional valuation metrics in order to consider multiple angles. In this case, using peer data again I compared forward EV/EBITDA to peers, and Dillards remains overvalued, this time 7% overvalued to this peer group's average. Dillards - EV/EBITDA vs peers (author worksheet & SA data) Using a third valuation metric, the trailing P/B ratio, from peer comparison data, again we can see Dillard's being overvalued, this time 47% vs this peer average. Dillards - PB ratio vs peers (author worksheet & SA data) I think this is sufficient evidence to point to this peer group presenting better valuation opportunities than Dillard's stock at this time. Again, I don't think the overvaluation is justified however I suspect it could be driven by Dillard's having a much better profit margin than these peers and indicators it is keeping costs down while expanding gross margin, as its Q3 commentary said. Risk Chart: Competition & Future Recessions Risks are Key Risks I created the following risk chart, picking four risks I think investors should consider with this stock and sector, and giving them various weights. Dillards - risk chart (author sheet) The greatest risk weight was given to the stiff market competition in retail and the fact that my earlier evidence showed Dillard's lagging far behind in market share vs brands like Macy's and Nordstrom, who I think both have a similar type of customer as Dillard's does. I personally have shopped many times at all three stores in various malls throughout the US, and have gotten used to the brand experience there. While it is not exactly the level of high-touch as Saks 5th Avenue, I would call it mid/upper market retail, despite Macy's also having a \"closeout rack\" with steep discounts and attempt to appeal to a wider customer base. Again, that is just my own subjective opinion and some readers may disagree. The risk of future recessions and pandemics can not be understated, as we see what business impact that has on retail, particularly since this is not a grocery store selling food essentials but is selling consumer discretionary items. Due to the proliferation of e-commerce, and as the data I pointed to shows continued growth in online/mobile customers, we should expect the risk of cybersecurity events too... which could impact Dillard's online store in many ways, including credit card data theft, which can have a huge brand reputational cost. The lowest risk is that of debt/credit risk of the overall company, as I have shown that this firm has a low debt-to-equity vs peers and an investment-grade credit rating from a major ratings agency. Conclusion: Agree with Analyst Consensus & Quant System To summarize, today I'm downgrading Dillard's one notch from my prior bullish call to a hold rating, agreeing with today's hold rating from the SA analyst consensus and SA quant system. My neutral sentiment is driven largely by a lack of strong buying indicators as the stock is overvalued and trading just above its moving average, while also not pointing to attractive future EPS and revenue growth numbers, and not being the best dividend play either. At the same time, let's say I'm being generous this holiday season and not calling it a sell just yet, and this is supported by it having a strong profit margin and low debt-to-equity and investment-grade credit rating, so I would not exactly throw it in the Christmas trash just yet. A Potential Exit Point: Wait For Equity Markets To Continue Up In case you're curious what would make it a \"sell\" in my view, I think the recent bullishness of equities markets could provide at least some further upside to notch it up further before selling, but then again if it beats EPS estimates after Q4 that could push up the share price somewhat, presenting a better exit point, perhaps. Recent events in the US, including elections, have also set up the equities market for potential further gains. Consider that on Nov. 11th, Morgan Stanley (MS) analyst Mike Wilson wrote that \"markets are readying for a lighter regulatory environment, supportive tax policy and a possible rebound in investor enthusiasm.\"  With that said, further upside to Dillard's I think is more likely going to be pushed by the overall market rather than it having superb fundamentals on its own right now, beyond just a nice profit margin and low debt. However, if you bought Dillard's right after my prior buy rating, you are already up +35% now on this stock, so I would say having bought it when it was \"on sale\" back then seems to have paid off.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2484396812"}