A Stock for the Stoic Investor

Jonathan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Mr. Market favors the stoic investor, though he dares not admit it. In fact, he tries to mask this preference, allowing the emotional investor to triumph in the short term. But should the latter be so foolish (not to be confused with Foolish) as to overestimate the duration of his or her lucky streak, there goes all the gains.

The real strength of a dispassionate approach lies in the ability to tune out the noise and listen to the fundamentals. Many a bargain lurks in the world's unloved stocks, just as many a talent goes undiscovered in Hollywood or Broadway.

That said, perhaps it is more than mere happenstance that one of today's more appealing retail stocks bears the name of a famous Stoic and Roman statesman: Cato.

The company is The Cato Corporation (NYSE: CATO), a specialty retailer selling value-priced clothing and accessories. Its stores operate under the Cato, It’s Fashion, and Versona Accessories brands.

The majority of the company’s base, the 1,000+ Cato stores average 4,000 square feet and are mainly located in small-town strip malls, many anchored by Walmarts or chain supermarkets. The approximately 210 It’s Fashion stores are about the same size, except for the subset of It’s Fashion Metro stores that are at least twice the size. Like Cato stores, they too are geared towards a more rural consumer, although they are present in Southeastern metropolitan areas such as Dallas, Orlando, and Charlotte.

Versona, the newest concept, is 10 stores strong, ranging from 6,000 to 10,000 square feet of costume jewelry and fashionable clothing. Offering a more upscale ambiance than Cato or It’s Fashion, it is modeled along the lines of privately held Charming Charlie and the Francesca’s Collections chain run by publicly traded Francesca’s Holdings (NASDAQ: FRAN). Its merchandise is more affordable than that of Francesca’s Collections and comparably priced to that of Charming Charlie, but similar in style. In making Versona the focus of the company’s expansion, management hopes to reach women with higher incomes than the typical Cato customer.

Just like Charming Charlie and Francesca's Collections boutiques, Versona stores are found in enclosed malls as well as strip malls and primarily in metropolitan areas. As Versona expands both within and beyond its current boundaries in the Southeast, it may have to base its real estate strategy on leasing space in new strip malls. Francesca’s Collections and Charming Charlie are young companies themselves, but they have rapidly taken over space in many established malls and shopping centers and they already have a greater geographic reach than Versona.

Cato’s Situation 

The company as a whole had a challenging Christmas season, characterized by a 2% drop in November same-store sales and a 7% drop in December. Accordingly, it has shed 10% of its market cap since the start of December while the stock has hovered around $27/share this year.

During this challenging period, management also gave signs that it felt shareholders could allocate capital more effectively than it could, declaring a $1.00/share special dividend in December. This payout was in addition to the usual $1.00/share dividend.

There doesn't seem to be much to like about Cato at first glance, but consider the following:

- The company has no debt.

- The dividend yield is 3.7%, one of the highest in the industry.

- By virtue of their geography, Cato’s chains have less physical competition than their Northeastern peers, e.g. the Lane Bryant and dressbarn stores operated by Ascena Retail Group (NASDAQ: ASNA). (Otherwise, they are very similar to Ascena's stores, competing at similar price points and offering similar merchandise. Cato lacks Ascena's dedicated tween and plus-size chains, but does cater to those markets in its Cato and It’s Fashion stores.) 

- Each member of the senior management team has been with the company for at least 20 years, and the team has a history of creating value.

<img src="http://media.ycharts.com/charts/594c316cfadef3b5fdceb7ef9c185712.png" />

CATO data by YCharts

If the business stagnates but holds its ground, investors should enjoy the steady dividend, which has a little room to grow. (The payout ratio stands at 44% now.)

The risk is that the company may fail to keep up with consumers’ ever-evolving tastes on one hand and with rivals’ competitive pricing on the other. The Cato chain is especially reliant on private labels, which are intended to be more fashionable than discount chains’ brands but more affordable than mall stores’.

Although private labels tend to be portrayed as more profitable than national brands, Cato’s chains achieve profit margins comparable to those of the T.J. Maxx and Marshalls chains operated by The TJX Companies (NYSE: TJX). T.J. Maxx and Marshalls compete at price points similar to Cato, yet benefit from stocking designer goods that enjoy substantial brand recognition. It’s no wonder that TJX has outperformed its peers over the last twenty years.

As I explained in September, however, TJX is priced for perfection. (The jury’s still out on whether I was right; the TJX stock price fell right after publication, but rebounded enough that the stock is where it was.)

I’m pretty excited about this stock, but I’ve never visited a Cato store. The closest one is an hour away. Yelp reviews for Cato, It’s Fashion, and Versona in particular are positive, but nothing can substitute firsthand experience.

Readers, what do you think of Cato stores?

Fool blogger Jonathan Lim (whywalkrandomly) has no position in any stocks mentioned, but may initiate a position in CATO two business days after the syndication of this article. The Motley Fool recommends Ascena Retail Group and The Cato. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus