Dillard's - Meaningful Beat

Introduction

In our initiating coverage report, we had highlighted the challenges pertaining to the apparel sector and Dillard's (DDS) in particular. While the pandemic exacerbated the ballooning problems for the departmental stores, even before the pandemic, the sector was grappling with competition from e-commerce players and off-price retailers leading to lesser footfalls in their malls. In particular, Dillard's had a ton of their own challenges due to its aging customer base and lack of innovative products. It was no surprise that Dillards was largely an underperformer even before the pandemic hit declining 8% compared to S&P's 19% rise and Apparel Retailer's index 10% rise. Fast forward COVID-19, the company reported a massive adjusted loss per share of $6.94 due to aggressive markdowns and store closures.

Data by YCharts

Q2 Earnings Corner

The company reported sales of $919mn, a decline of 35% compared to the previous year, which fell slightly short of the expectations as the stores opened up, albeit with reduced operating hours. The sizeable beat was witnesses in retail gross margins which improved 239 basis points of sales compared to the prior year second quarter primarily due to decreased markdowns while the consolidated gross margins improved 271 bps to 30.4%. In contrast, gross margins for Q1 2020 was a paltry 12.8%. The retailer's aggressive inventory clearing strategy in March and April worked wonders leading to a strong beat on the gross margins for the current quarter. SG&A expenses declined $142mn to 29.1% of sales, slightly higher than the last year, but significantly better than expectations at 32%. This was also as a result of payroll expenses declining 41% for the quarter. To sum it up, the company reported a massive earnings beat of ($0.37) compared to expectations of ($4.6) per share. It mentioned that sales performance in the stores since re-opening through August 1, 2020, was approximately 72% of prior year sales on corresponding days. The company further continued on its inventory management reducing the purchases by 62% compared to the previous year, a significant increase from the 14% decline in the previous quarter, enabling them to post such a huge margins beat and decreasing its inventory base by 20% which bodes well for the coming quarters.

Valuation

The company's Q2 results have displayed that strong cost control and aggressive inventory management can lead to margin expansion. However, the company expects to post an operating loss for FY20 without giving any definitive indication of future performance. This entails that a quarter of aggressive margin expansion may not be sustainable in the future. We model 3Q EPS at ($0.03) and revise full-year EPS estimate at ($4.5) from ($11.1) before versus consensus estimates of ($11.4). However, due to the aggressive run-up in the stock post the results, Dillard's investment continues to be speculative for high-risk tolerant individuals. That being said, we upgrade the stock to Neutral and increase the target price to $28 per share (3x 2021E EV/EBITDA).