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Equity Valuation Cato Corporation

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Sample Equity Research Report by JaZaa Financial Advisory Pvt Ltd

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Equity Valuation Cato Corporation

  1. 1. Cato Corporation (NYSE:CATO) CATO CORPORATION (NYSE: CATO) Current Market Price: $27.5 Fair Price: $44.85 Expected Returns: 63% Address Website Exchange Industry Market Cap 52 Week Range Beta Price/Book Price/Earnings (Forward-2012) Price/Earnings Cato Corporation, 8100 Denmark Road, Charlotte, NC 28273-5975, (704) 554-8510. http://www.catofashions.com NYSE Apparel $819.5 Million $22.81-32.32 0.74(Company website) 2.0 9.0 12.3 (at current prices) Fundamental Analysis INDUSTRY ANALYSIS Apparel stores generally sell clothing, footwear and accessories to consumers which makes it a subset of retail industry. The industry suffered setbacks during the economic crisis and then regains the momentum contributed by the growth in population and rising disposable income of the consumers and international trade levels. Research and Markets study forecasted global apparel and accessories industry to grow modestly over the next five years up to 2017 and reach an estimated US $1,369 billion in 2017 with a CAGR of 4% with the growing demand from middle classes in emerging economies. There’s also a change is witnessed in recent years about the brand consciousness of the consumers. Consumers have brand conscious and indulging in purchases of branded cloths, footwear’s etc. which will lead to stronger revenue growth. IBIS World forecasted that over the next five years industry revenue will grow at an annualized 0.1% to generate revenue of $557.9 billion, a 2% increase from 2011. Rating agency Moody’s also raised its outlook for the US clothing industry in view of the falling cotton prices and steady rise in demand. It said the drop in cotton prices will drive 7%-8% increase in operating profit of the US clothing companies. According to Marketline report, the global apparel retail market is expected to reach $1.3 trillion in 2013 which is a 13% expansion of the industry in five years. Women wear is the largest segment of the global apparel retail industry having a share for 51.1% of the Page 1
  2. 2. Cato Corporation (NYSE:CATO) industry's total value and America accounts for 36% of the global apparel retail industry value. COMPANY ANALYSIS Cato Corporation is a specialty retailer which operates women's apparel stores by the names Cato, Cato Fashions, Cato Plus, and It's Fashion! Versona Accessories. The company operates more than 1288 specialty stores throughout the US. The merchandise offered in Cato stores concentrates on latest fashion apparel and quality comparable to mall specialty stores. Its offerings included latest fashion apparel and accessories for juniors, misses, and large-size female customers of low to middle income. The company has mixed performance from the beginning of the fiscal. It reported flat sales in October 2012. Sales for the third quarter ended October 27, 2012 were $197.6 million, a 2% increase over sales of $194.1 million for the third quarter ended October 29, 2011. However, same-store sales for the third quarter decreased by 2%. However, year on year the company registered slight increase in total revenue. In 2011, it reported revenue of $926 million which increased to $931 million in 2012 and trailing twelve month (TTM) revenue stands at $930 million. However in the latest quarter the revenue declined by 1.16%. The company also did not have a healthy Q2 performance. In the second quarter the net income declined to 7.5% from 7.7% of the total revenue compared to the same quarter in the preceding year. However, the company’s net income increased marginally to $65 million in 2012 from $ 59 million in the previous year. Total gross margin increased by 0.1% for the second quarter of fiscal 2012 compared to previous year same quarter. The Company believes the second quarter and first six month period of fiscal year 2012 were both adversely impacted by continuing customer uncertainty regarding the country’s economic and political situation. Year on year the company registered marginal increase in return on equity from 18.72% to 18.73% in 2011 and in TTM it stands at 16.89%. The return on assets also increased marginally from 11.51% in 2010 to 12.08% in 2011 and in TTM it stands at 11.64%. The company also succeeded in reducing the total current liabilities to 24.07% in the last quarter from the previous 28.49%, although long term liabilities increased slightly. Overall the company reduced the liabilities to 29.64% in the last quarter from 37.64% in the previous fiscal. The company also registered an increase in earnings per share (basic) to $2.21 in 2011 from $1.96 (TTM-$2.27). The share of the company registered year to date change in prices at 17%. Cato’s PE is lower than the industry average while its PE stands at 12.3 whereas industry average stands at 18.7. While forward PE of Cato’s stand at 9.0. Page 2
  3. 3. Cato Corporation (NYSE:CATO) It is expected the stock will improve its position and the mixed performance is also contributed due to operation in a cyclical industry. It expects the third quarter earnings will be near midpoint of prior range. Year to year the company has opened 25 new stores, relocated seven stores, and closed seven stores. As of October 27, 2012, the company operated 1,306 stores in 31 states, compared to 1,292 stores in 31 states as of October 29, 2011. As evident from the graph the stock picked up the momentum in Dec’11 and is continuing its movement upward albeit with volatility. From Sep’12 the stock has done some load shedding which is because of muted results and profit booking. The price decrease is also due to some cyclical nature of stock. From a long term value perspective we feel the stock is good with good fundamental value and would soon pick up upward trend. Key Data (unaudited) six months ended 28 Jul 12 $ million Revenue 509,407 Earnings per share 1.68 US $ (Basic) Book Value Per Share US $ 13.78 Operating Margin 11.94% Return on Equity 4.30% (unaudited) six months ended 30 Jul 11 $ million 510,466 1.65 12.54 12.08% 4.90% year ended 28 Jan 12 $ million 931,458 2.21 12.57 10.89% 17.68% Page 3
  4. 4. Cato Corporation (NYSE:CATO) Return on Assets Net Margin Asset Turnover Leverage 3.02% 7.49% 40.37% - 3.30% 7.73% 42.68% - 11.76% 7.04% 167.05% - DUPONT ANALYSIS ROE=Net Profit Margin x Total Asset Turnover x Leverage The return on equity in 1H12 decreased significantly due to the significant decrease in asset turnover and net margins. It is expected that this pattern won’t continue and asset turnover will improve with increase in sales and improved economic conditions. I MPORTANT HIGHLIGHTS FINANCIAL HIGHLIGHTS  Cash and Cash equivalents reduced to $34,893,000 in January 28, 2012 from the previous year.( January 29, 2011-$48,630,000)  EBIT increased from $75,765,000 in July 2011 to $ 78,919,000 in July 2012 six months ended.  Dividends per share increased to 0.480 in July 2012 from 0.415 of the previous same quarter six months ended.  Book value per share increased to $ 13.78 in the second quarter from $12.54 of the same quarter in the previous year. OPERATIONAL HIGHLIGHTS  Same store sale was flat in Oct 12 still it is expected it will reach near guidance range in Q3.  Selling, general and administrative expenses increased in Q2 to $59,220,000 from the previous year same quarter’s expenses. ( $58,995,000 in July 2011)  Year-to-date, the Company has opened 25 new stores, relocated seven stores, and closed seven stores.  Depreciation increased to $5,742,000 in Jul 2012 compared with the previous year same quarter which was $5,371,000.  Paid $0.25 per share quarterly dividend of the Q2.  The company has a significant investment in other assets like state/municipal bonds, corporate bonds, auction rate securities, US Treasury notes etc. Page 4
  5. 5. Cato Corporation (NYSE:CATO) RELATIVE VALUATION Industry CATO TJX $820.1 $ 31.8 Million Billion 926 21,942 Million Million USD USD 12.4 18.6 GPS LTD ROST LULU URBN $ 16.3 Billion 14,664 Million USD 18.8 $ 13.9 Billion 9,613 Million USD 19.8 $13.0 Billion 7,866 Million USD 17.6 $10.1 Billion 712 Million USD 47.0 $5.3 Billion 2,274 Million USD 28.7 Market Cap — Revenue (2011) — Price/Earnings TTM Price/Book — — 2 9.1 5.6 - 7.6 14.0 4.5 Price/Sales TTM Rev Growth (3 Yr Avg) — 0.9 1.3 1.1 1.4 1.4 8.7 2.1 — 2.8 6.9 0.1 4.7 9.9 41.5 10.5 EPS Growth (3 Yr Avg) — 24.7 22.9 5.2 60.8 34.9 64.6 0.6 Operating Margin % TTM — 11.1 11.5 10.3 13.9 12.7 27.3 11.1 Net Margin % TTM — 7 7.1 5.9 7.1 8.0 18.5 7.2 ROE TTM Debt/Equity — 16.9 0 53.0 0.2 29.5 0.9 6.8 47.0 0.1 35.6 0 14.9 0 Price/Earnings 18.7 12.3 18.6 18.8 19.8 17.6 46.5 28.7 Price/Book 4.5 2.0 9.1 5.6 -55.6 7.6 13.8 4.5 Price/Sales 1.1 0.9 1.3 1.1 1.4 1.4 8.6 2.1 Price/Cash Flow 10.4 9.5 11.0 9.4 11.5 11.0 40.7 18.9 Dividend Yield % 1.3 3.4 1.3 1.5 2.0 0.9 - - (Data Source: www.morningstar.com) CATO has grown over the years and has increased its footprint to 31 states of US. It is still a minuscule in the apparel industry and has to go long to attain the prowess of some of its competitors like TJX but still it made considerable progress. The company has not changed its strategy with respect to business and going by its old strategy. It is evident from the above table CATO has considerably good EPS growth rate. Its price to sales Page 5
  6. 6. Cato Corporation (NYSE:CATO) ratio and price to book ratio is among the lowest in the industry. It is the best in dividend yield in the industry and only second to URBN with respect ROE TTM. In spite of no strategic moves CATO has grown considerably good since its inception but it is still lagging behind the big players of the industry. From the above it is also evident that it has outperformed others big players in parameters like operating margin TTM and net margin TTM. FAIR PRICE CALCULATION NUMBER OF STORES/ PER UNIT REVENUE ESTIMATES 2007 Stores open at end of year Per Store Sales Growth in per store sales 2011 2011 2012 Nine Nine Months Months 1,306 1,318 1,281 1,271 1,282 1,288 1,292 633 2008 660 4% 2009 686 4% 2010 712 4% 715 0% 541 Full Year 2012 Optimistic Pessimistic 1,318 1,306 731 2% 710 -1% 537 -1% PROFIT AND LOSS ESTIMATES FOR THE YEAR ENDED (In ‘000 except per share data) 2007 2008 2009 2010 2011 2011 Nine Months 2012 Nine Months Full Year 2012 Optimistic Full Year 2012 Pessimistic Retail sales $834,341 $845,676 $872,138 $913,079 $920,622 $699,104 $701,815 $964,092 $927,062 Total revenue $846,437 $857,718 $884,001 $924,685 $931,458 $707,151 $709,412 $974,528 $938,870 Cost of goods sold $572,358 $562,375 $553,808 $563,370 $574,468 $429,379 $430,690 $591,644 $589,991 Selling, General and Administrative Depreciation $211,088 $227,487 $245,071 $251,097 $239,362 $179,776 $178,828 $245,658 $245,004 $22,527 $22,833 $21,803 $21,914 $22,095 $16,096 $16,859 $23,159 $23,050 Income before income taxes Income tax expense $49,233 $52,610 $66,920 $92,772 $100,271 $84,667 $85,740 $117,782 $86,316 $16,914 $18,976 $21,935 $33,921 $35,437 $29,938 $32,016 $43,981 $30,718 Net income $32,319 $33,634 $44,985 $58,851 $64,834 $54,729 $53,724 $73,801 $55,597 4% 34% 31% 10% 29,501 29,162 29,162 29,162 Income Growth Rate Shares Issued Basic earnings per share $1.02 $1.14 $1.53 $2.00 $2.21 $1.86 $1.84 $2.53 $1.91 Diluted earnings per share $1.02 $1.14 $1.53 $2.00 $2.21 $1.86 $1.84 $2.53 $1.91 Page 6
  7. 7. Cato Corporation (NYSE:CATO) GROWTH RATES AND COST OF EQUITY CALCULATIONS AT YEAR END 2007 2008 2009 2010 2011 $114,578 $144,803 $200,915 $234,851 $245,989 $144,114 $164,639 $214,024 $251,523 $272,139 2 2.1 2.3 2.5 2.7 Total assets $420,792 $435,353 $492,063 $532,759 $551,089 Total Stockholders’ equity $247,370 $261,813 $298,649 $334,014 $366,679 0.41 0.40 0.39 0.37 0.33 Return on Assets 8% 8% 9% 11% 12% Return on Equity 13% 13% 15% 18% 18% $18,330 $19,443 $9,960 $19,559 $35,890 $20,525 $49,385 $37,499 $20,616 Average 2% 6% 4% 2% 4% Cash, cash equivalents, short-term investments and restricted cash Working capital Current ratio Debt Ratio Capital Expenditure Change in Working Capital %of Revenue ROA 11.6% Retention Ratio 60% Debt/equity Interest rate 1.00 8.0% Tax Rate 35.3% Fundamental Growth Rate 10.9% Income Growth Rates Forecast High Growth Period Analysts (Source) FT.Com Weight 21% 0.2 Five Years Average Growth Rate 19% 0.3 Fundamental Growth Rate 11% 0.5 Weighted Average Forecasted Growth Rates 15.33% Expected Debt Ratio 0.50 Beta 0.74 Risk Free Rate 3% Return from Market 13% Cost of equity 11% 3 Yr Avg Return S&P500 Page 7
  8. 8. Cato Corporation (NYSE:CATO) FREE CASH FLOW TO EQUITY AND FAIR PRICE CALCULATION Free cash flow calculation All Figures in '000s except per share data Year Growth in Net Income Net Sales Depreciation Net Income CAPEX Change in Working Capital Cash Flow to equity High Growth 2012 E Stable $938,870 $23,050 $55,597 $21,929 $33,883 2013 E 15.33% $1,069,222 $26,585 $64,123 $24,974 $38,588 2014 E 15.33% $1,233,181 $30,661 $73,956 $28,804 $44,505 2015E 15.33% $1,422,282 $35,363 $85,296 $33,221 $51,329 2016 Onwards 4% $1,479,173 $36,778 $88,708 $34,549 $53,383 $71,979 $82,611 $95,279 $109,890 $114,285 11% 11% 11% 11% 11% Cost of Equity Terminal value Present value of cash flows FCFE (In '000) No of shares $1,721,994 $65,058 $67,490 $70,356 $1,105,096 $1,308,000 29,162 Share price per share acc to valuation Conservative $44.85 Optimistic $56.85 Current Market Price $27.50 LIMITATIONS OF THIS STUDY 1 – Fair price calculation is based on some growth rate assumptions which may or may not hold. 2 - It has been assumed that company’s current debt ratio would be maintained. 3 – We have taken guidance by the company on the face value and have not analyzed and we do not have sufficient data to analyze whether the company is performing as per guidance till the next result. Page 8
  9. 9. Cato Corporation (NYSE:CATO) Disclaimer “This document has been prepared by JaZaa Financial Advisory Pvt. Ltd (hereby referred to as ‘JaZaa’). This Document is subject to changes without prior notice and is intended only for the person or entity to which it is addressed to and may contain confidential and/or privileged material and is not for any type of circulation. Any review, retransmission, or any other use is prohibited. Please note that this document does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. The information contained herein is from publicly available data or other sources believed to be reliable. While we would endeavour to update the information herein on reasonable basis, JaZaa, its subsidiaries and associated companies, their directors and employees are under no obligation to update or keep the information current. Also, there may be regulatory, compliance, or other reasons that may prevent JaZaa and affiliates from doing so. We do not represent that information contained herein is accurate or complete and it should not be relied upon as such. This document is prepared for assistance only and is not intended to be and must not alone be taken as the basis for an investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this document should make such investigations as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult its own advisors to determine the merits and risks of such an investment. The investment discussed or views expressed may not be suitable for all investors. We do not undertake to advise you as to any change of our views. Affiliates of JaZaa may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject JaZaa and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction. JaZaa & affiliates may have used the information set forth herein before publication and may have positions in, may from time to time purchase or sell or may be materially interested in any of the securities mentioned or related securities. JaZaa may from time to time solicit from, or perform investment banking, or other services for, any company mentioned herein. Without limiting any of the foregoing, in no event shall JaZaa, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any liability for any damages of any kind. Any comments or statements made herein are those of the analyst and do not necessarily reflect those of JaZaa.” www.jazaa.in Page 9

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