This Special Dividend is Not So Special After All
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
DSW Inc. (NYSE: DSW) reported that the company will pay a special dividend of $2 per share on October 26 to shareholders of record as of October 16. The company says that this, “reflects the company's strong cash flow and focus on returning value to its shareholders.” Normally I'm all about dividends, I believe they are an effective way for companies to return profits to shareholders. I prefer dividends over share buybacks because I can spend a dividend or choose to reinvest it. While share buybacks are usually seen as a positive move, many companies buy shares high and stop buying when the prices drop effectively wasting shareholders money. So what's wrong with DSW's special dividend?
Is Management Saying the Stock is Overvalued?
I know I'm second guessing DSW management, but the fact that the company has a $100 million share repurchase plan and isn't making any share repurchases worries me. In fact, in the last four quarters the company has actually issued new shares in three of them. While DSW is beating earnings estimates by about 10% on average, this share dilution isn't being addressed and over time will lead to tougher earnings comparisons. In addition, it smacks of irony that the company is spending $91 million on this special dividend, and has a $100 million share repurchase plan in place that's not being used. This lack of share repurchases says to me that the board doesn't see the stock as that great of a value. Logically if they believed the stock was a great deal, they wouldn't be announcing the special dividend, they would be buying back stock. I guess I sort of understand their hesitation with the stock trading at nearly 20 times forward estimates and only expecting 10% earnings growth.
Why Not Expand the Business Faster?
In the last few years DSW has increased their cash flow and increased their capital expenditures as the business has expanded. In the last four quarters, the company's capital expenditures have averaged about $22 million per quarter. This gives us an indicated $88 million per year run rate. With a special dividend of $91 million, in theory the company could have put this money into expanding its store presence at a faster rate thus increasing earnings growth. The fact that management added 27 new stores in the first half of the year, and expects to add 27 new stores in the second half is good news for investors. What should be worrisome for investors is analysts only expect 12% revenue growth this year and then less than 9% revenue growth next year. If the company is growing revenues in the high single digits and analysts only expect 10% EPS growth, why not boost this growth rate? The business is generating significant cash flow so why not plow this $91 million back into the business to generate even more cash flow? Something doesn't seem to add up.
Why Not Just Increase the Regular Dividend?
The main thing about special dividends that is an issue for me, is their lack of predictability and short-term nature. Usually when a company declares a special dividend, the stock will pop a little on the news and then after the record date go back down. This is very likely to happen with DSW as well. In the last fiscal year, the company generated enough free cash flow to cover their dividend with just a 23.05% payout ratio. With almost $140 million in free cash flow and regular dividends of just $32.15 million expected, the company has plenty of room to increase the regular dividend. If management is so convinced of the strength of the company's cash flow, this would be a more permanent solution to return value to shareholders. In theory, an increase in the regular dividend also makes the stock more attractive as the yield would increase. If the company split this $91 million over the year it would add $22.75 million to the quarterly dividend payment. With about 44 million shares outstanding, this would change the dividend to about $0.70 per quarter or an effective annual yield of 4.31% at current prices. This would be much more attractive to income investors than the 1.1% yield the stock current pays.
The Answer to All of These Questions – Competition is Fierce:
The shoe industry is rife with competition. One of the company's primary competitors is Collective Brands (NYSE: PSS), which operates the Payless and Stride Rite store brands. This company operates more than 10 times the number of stores compared to DSW, but the financials reflect the challenge of its size. Collective Brands is expected to grow earnings at about 8% over the next few years. However, managing costs has been a challenge with their gross margin falling from over 35% last year to under 30% this year. The company also is dealing with net long-term debt of over $400 million, whereas DSW is debt free.
One company that is more of a competitor than DSW might realize is the big box retailer Target (NYSE: TGT). Target's shoe selection is of course much smaller than DSW, but the company has the advantage of being a more popular location. Target sees millions of people every day shopping for groceries, electronics, cleaning supplies, baby products, and more. It's not unusual to see the shoe aisles at Target crowded with people. While the company offers a much smaller selection, the low prices and sufficient styles makes it easy for an individual or family to buy a pair of shoes while getting other items. I know many people have bought shoes at places like Target and Wal-Mart out of convenience instead of making an extra trip to a store like DSW.
Conclusion:
I know that existing DSW shareholders are probably fine with this special dividend. The bottom line for me is, I see one time dividends as a special announcement that the company can make to get press and not as a true vote of confidence in the business. If a company truly believes in their business, they make a longer-term use of their cash than a one-time event. DSW while I applaud your decision to return value to shareholders, I just wish you went about it a different way.
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