Description

Citi Trends (CTRN) is a value-priced retailer of urban fashion apparel and accessories which on focused on “the fashion preferences of value-conscious consumers, particularly African-Americans.” In our view, at current prices, Citi Trends’ shares should also appeal to value-oriented investors who like buying growth at cheap prices.

Like many small-caps, the company has seen its shares decline in recent months with shares down 37% from the highs achieved in late August. This in part can be attributed to tepid F3Q results, but notably, shares were already on a downtrend prior to reporting earnings (resulting in cutting the high end of the full-year guide by $0.04, roughly 2.5%). Equally importantly, while 3Q represented a slight miss, the company maintained its 4Q guidance of $0.60-$0.65, resulting in full year EPS of $1.66-$1.71 versus $1.26 in FY17, or 32-36% y/y earnings growth. Notably, FY16 EPS was just $0.91, meaning earnings grew almost 30% in FY17 versus FY16.

Currently, shares trade at 12.4x the midpoint of FY18 earnings and 10.7x our estimate of $1.95 for FY19, but notably the company has just over $6 per share in cash, so ex-cash, the P/E multiples decline to an undemanding 8.7x and 7.5x FY18 and F19 respectively. With $6+ in cash (approximately $83mn with 12.9mn shares outstanding) almost 30% of the market cap is cash. The company’s solid cash position coupled with its recently authorized $25mn share repurchase program (just under 10% of shares outstanding at current prices) offers what we believe is a considerable margin of safety. It’s worth noting that the company recently completed another $25mn program which it executed within 6 quarters. At current prices, we hope they move more expeditiously considering they have approximately $80mn of cash and equivalents, as well as a $75mn credit facility. The company also has a small 1.6% dividend.

The last several years have been marked by solid margin improvement (GMs from 34.8% in FY12 to 38.3% in FY17), driven by better mix and inventory management, and leveraging expenses over a judiciously increasing store count. As of November 3rd, the company operated 557 stores in 32 states. With products that are sold at a typical 20%-70% discount to the prices at malls and specialty stores, and the majority of brands in house, the potential for disintermediation by e-commerce is fairly limited.

The company typically adds 15-20 stores (net of closures) on an annual basis, resulting in a growth in a targeted growth in square footage of 2-3% annually. Similarly, the company has recently targeted, and achieved 3% annual comparable same store sales growth – however 3Q, net of timing differences, lagged at .7%, although that followed a 7.4% increase in 3QF17, meaning for the 2 year period the company was very much on plan. For the first 3 quarters of F18 same store sales growth was 2%, and 4Q guidance is for 1-2%, so it appears that F18 will be slightly below plan. However, F17 was up 4.5%, so again, on a 2 year basis, the company appears very much on plan.

For CTRN to achieve its annual EPS growth objective of 12-15% (which it dramatically beat last year and should again in F18) the playbook is fairly straightforward – 2-3% square footage growth, 3% SSS growth, modest operating leverage improvement, and a reduction in share count. It’s worth mentioning that management has a solid history of conservatism in its guidance. While 3Q came in light, due to women’s apparel mix that was not quite right (but has been remedied), the full year guidance of $1.66-$1.71 is well above the $1.55-$1.70 that the company affirmed on its 1Q earnings call in May (shares were 50% higher at the time). Admittedly, the guidance at the high-end is now $0.04 below the $1.65-$1.75 set after 2Q, but notwithstanding momentum selling, a 33% decline seems well overdone. We believe making 4Q numbers will be a potent catalyst to reinvigorating shares.

Touching a little bit on what has driven the company’s margin improvement over the last several years we’d point out 3 major factors. First, the company implemented an oft-discussed merchandise planning system in 2014-2015 which allowed better inventory planning and allocation, which was also coupled with markdown optimization.

Second, the company diversified into much more non-apparel items including accessories (32%, including footwear) and home (5%). Accessories and home have increased from 21% of sales in FY11 to 37% of sales in F17. This represents both a broader product mix – making the company less dependent on any single category, and a source of additional revenue.

Source: Citi Trends Investor Presentation

Third, the number of units sold has grown far more rapidly than overall customer count – likely due to the company’s incremental product offerings. From F12 to F17, customer transactions have grown 23.8% while units sold have grown 36.6%. Clearly this marks a dramatic improvement in sales efficiency.

Source: Citi Trends Investor Presentation

Valuation

We believe that if Citi Trends achieves its full year guidance the stock will likely return to its former highs. Applying a P/E of 12x plus cash of $6 per shares on F19 EPS of 1.95 results in a price target of about $30, or almost 45% upside from current prices. Using a DCF, assuming 10% earnings growth for the next 5 years, a 2% terminal growth rate, and an 8% discount rate results in a price target of $37, or about 80% upside. Our bottom line is that this is a story that is not broken, representing a retailer with a unique niche, excess capital which is being returned (faster please!) and is likely to achieve F19 EPS in excess of the 12-15% which the company has guided as its target model. We are optimistic the company has laid out achievable growth metrics and can compound earnings and deliver shareholder value at above market rates from its current price. Further, as opposed to many other retailers, this is a domestic business that should not be impacted by China trade wars.

Please note that in the valuation at the top I am using FY19 and FY20 which equate to essentially Calendar 19 and Calendar 20. Both assume approximately 13.5% earnings growth. Neither P/E accounts for $6+ of cash.

Catalyst

Solid 4Q results.

Maintenance of long-term growth objectives.

Accelerating comps in F19, particularly as the company approaches easier 2H comps.