Investopedia ran an article in October 2008 discussing a rather contentious disagreement between several large investors and the Dillard family. The family controls Dillard's Department Stores (NYSE:DDS) through their ownership of the Class B shares that entitle them to elect two-thirds of the directors. The issue was eventually resolved but it brought to light the nasty side of dual class structures and non-performing management. Twenty months later, none of it seems to matter. The company announced stunningly positive first quarter results May 14, including a 2% increase in same-store sales - something it hasn't done in a long time. Dillard's looks as if it's come back from the dead. I'll examine whether its good fortune can continue.
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Bad Track Record
Out of the past ten years, Dillard's has seen annual revenue declines in seven of them. In terms of profits, it's lost money in four of the last nine quarters. These are hardly confidence builders for investors who saw its stock price sink as low as $2.78 at the end of 2008. However, those able to see beyond the negatives, buying at the bottom have been rewarded handsomely since then. It stock was up 378.8% in 2009 and is up another 50.7% in 2010. Those are giant-sized returns. No matter what you think of CEO William Dillard II's compensation or the dual class structure, you have to tip your hat to all the good things happening right now within the company.
Dillard's & Peer Group
|Company||2009 Return||YTD Return|
|JC Penney (NYSE:JCP)||39.1%||5.0%|
Until recently, Gap (NYSE:GPS) had been fighting a similar problem to Dillard's in that no matter how profitable it was, it couldn't seem to get same-store sales headed in the right direction. Many analysts cited this as a reason for not buying Gap stock. While positive comps are nice, they're meaningless if done at a loss. Dillard's senior management seems to have come to this very same conclusion. For instance, in the first quarter it improved gross margins by 300 basis points, reduced operating expenses by 100 basis points or $20.7 million and reduced comparable store inventory by 12% year-over-year. Earnings and cash flow were off the charts. Net income grew by 534% to $48.8 million, ending the quarter with $305 million in cash - and that's after buying back $105 million of its stock. This is execution at its finest.
Over the past five years, Dillard's have been on track with the broader S&P 500 index, although in the past few years it was hit much harder, losing most of its value. Why such a difference? Well, there is the dual class issue discussed earlier but I don't think that's the reason. For me, the biggest thing that stands out at Dillard's is the inconsistency in its operating margin. Over the last 10 years it's varied from as high as 4.2% in fiscal 2007 to as low as -1.7% in fiscal 2009. Using Gap as an example once more, its operating margin the last 10 years has been, with the exception of 2002, between 7% and 12% and on the rise the past four. Investors like certainty and Dillard's provides very little.
Dillard's delivered a 6.5% operating margin in the first quarter versus 2.1% last year. If it can consistently grow its operating margin quarter-to-quarter, year-over-year, it should be able to test its five-year high of around $40 soon enough. While Dillard's is definitely back from the dead, it's tough to know if it can stay alive. (For additional stock analysis, check out Long-Term Utility Dividends.)
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