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Cato Catches a Bid

May 19, 2011 | About:
Henry W. Schacht

Henry W. Schacht

13 followers
The value retail market is dead. So say many analysts and their fans in the financial press. The rationale is obvious, they say. Thanks to high unemployment, only retailers catering to the upper middles to the upper uppers are doing well. This means Nordstrom (JWN), Saks (SKS), and even Macy's (M).

Apparently, you poor saps who collect a paycheck don't buy clothes during tough economic times!

Money managers love to own the "elite" retailers. After all, they are well-known companies with cache. You can talk about these at the cocktail party without embarrassment. Nonetheless, for those willing to lower themselves, the value arena is not devoid of opportunity.

Witness today's report from Cato Corp (CATO). Now I know that many of you get queasy if you've never heard of a company, but please hang in there. Cato is a value-priced women's retailer that is clearly providing women a product they want at a price they can afford. This is the only explanation for the company's serial successes in recent years. For the most recent quarter, sales were up 5% and earnings were up 22%.

Cato's market value is just less than $800 million (29.5 million shares at 26.80 a share). The company's 2011 earnings guidance is now $2.11 to $2.19 a share. So why get excited about $62 million in projected earnings? A multiple of 12 to 13 times earnings?

For one, there is the fact that Cato is putting up these numbers in a very difficult environment. Just imagine what they'll accomplish if/when employment picks up?! But if you lack imagination (like me) and still are not convinced, please take moment to look at Cato's balance sheet.

As of April 30, Cato shows $261 million in unrestricted cash on hand (and no debt). That's $8.85 a share. Or 35% of the company's market value. Adjusted for this cash, Cato trades at just 8.5x earnings. You could say that Cato is risk averse, but their cash hoard is not due to a lack of dividends. The company pays an 18.5 cent quarterly dividend, a yield of 2.75%.

A cash-rich retailer trading at a single-digit multiple that is growing in a difficult marketplace? Say it ain't so!

Call me a fan of the company (especially at this price).

That said, there are caveats. I am less than excited by the company's dual share class structure and Mr. Cato's $3+ million compensation package. Apparently owning 2 million shares isn't enough. But by owning (only) 7% of the outstanding shares, our company's leader controls 40% of the voting rights. Seems fair to me!?!! Or not.

Clearly, someone wants the benefit of a private company, while still being public. Let them eat cake! It is a shame, but this is typical of those who have the votes to set their own pay. It is also the hallmark of a weak board of directors.

Nonetheless, despite the current valuation, it is unlikely that Mr. Cato is going to realize that his super-voting shares are part of the problem. (Note to Mr. Cato: They are!)

More realistically, I'd like to see a lower cash hoard and higher dividends. On this front there is hope ... if only owing to the self-interest of Mr. Cato. Cato's "board of directors" which will be meeting on May 24. Look for a dividend increase.

In discussions with the company, I have suggested a self-tender offer and/or a large special dividend, but don't hold your breath. There is only one shareholder whose opinion matters, regardless of how short-sighted it may be.

So here's hoping the board comes to their senses, because the value is there to be unlocked.

Nonetheless, if the board doesn't return a significant amount of cash to shareholders (including those of us not named Cato), then Cato's conversion into a glorified savings account will continue. If this is the case, ignore all the superlatives above. And sell.

Cato is a good business, but if corporate governance does not improve, the discount to fair value may be permanent. Nobody wants to partner with managers whose disdain for outside shareholders is on full display.

Disclosure: Long CATO ... for now.

About the author:

Henry W. Schacht
Henry W. Schacht, CFA is the founder of Schacht Value Investors, an investment management firm serving individuals and institutions. He currently serves as President and Chief Investment Officer. He earned his MBA at the University Of Chicago Graduate School of Business and a BBA in finance from the University of Notre Dame. Mr. Schacht is a member of the Association for Investment Management & Research (AIMR), the Investment Analysts Society of Chicago (IASC), and the National Association of Corporate Directors (NACD).

Rating: 3.6/5 (14 votes)

Comments

bpgamecock
Bpgamecock premium member - 3 years ago
Henry - I read CATO's 2010 10-K tonight. One question thus far - they have $65 million of their $235 million "cash equivalents" invested in "Variable Rate Demand Notes." What the heck are the risks with these? Sounds like a fancy term for "stuff we don't understand but we're trying to get an extra quarter-point in annual yield." Reminds me of Auction Rate Debt (of which CATO has $3.5 million in perpetual default).

BTW, really enjoy your write-ups.

Thanks,

Bryce
hschacht
Hschacht - 3 years ago
http://www2.standardandpoors.com/spf/pdf/index/VRDO_Primer.pdf

I highly recommend the link above in order to understand Variable Rate Demand Notes... especially bullet pt 2. These are NOT auction rate preferred securities and are dramatically less risky.

That said, I suspect that Cato will get its auction rate money too as most issuers are being forced to buy them back.

Thanks and I hope that helps.

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