City Trends Trades At Fair Value (NASDAQ:CTRN)

Citi Trends’ (CTRN) second-quarter results caught our attention. The off-price retailer saw revenue growth when its main competitors, such as Ross Stores (ROST), The TJX Companies (TJX), and Burlington (BURL) all showed second-quarter losses in the double-digits.

As a result, the market has rewarded the company with a rising stock price and strong momentum. The company is trading at its 52-week highs and has been in an upward trend since April when the stock reached its low of approximately $7.

Management has reiterated its sales guidance for Q3, calling for flat to down single-digit sales comps. With back-to-school season delayed and markets still rebounding after the lockdowns, we believe the guidance given still shows strong relative performance, especially since CTRN doesn’t operate an e-commerce channel and depends 100% on its brick-and-mortar stores. The company has also reinstated its $30 million share repurchase program, which is expected to be funded from cash on hand. After repaying the $41.6 million drawn from its revolver in Q1 as a precaution, we estimate the company should have around $100 million in cash on its balance sheet.

We believe the company could do well in a recessionary environment. The company targets low to mid-income households with a focus on the African American community. In hard times, discount stores tend to perform well, as consumers become more value-conscious. From a shorter time horizon, a new stimulus package could be a boost to sales. Management noted that stimulus checks played a role in its second-quarter sales performance.

The company currently trades at an EV/EBITDA multiple of 12x, slightly higher than its 5-year average EBITDA multiple of 11x.

We are waiting for Q3 results and possible commentary about Q4 guidance when the company reports its numbers in the coming months. We would like to know how sustainable CTRN’s operating momentum is in an environment where most retailers would have worked out their supply chain constraints.

With sales coming strictly from its brick-and-mortar stores, there is also the risk of another round of lockdowns disrupting the business if COVID cases increase as we approach winter. CTRN could be a winner in a recession, but we would rather stay on the sidelines, for now, waiting for more clarity.

Solid Q2 results

With no e-commerce channel, CTRN depends entirely on its retail stores to generate sales. The same can be said about off-price competitors Ross Stores, TJX Companies, and Burlington. However, unlike the big three off-price retailers, CTRN reported sales growth of 18.2% to $216 million for its second quarter, compared to its prior-year period. The company also ended the quarter with a strong positive comparable store sales increase of 32.2% in reopened stores.

For comparison, Ross Stores saw a decline of 32.7% in net sales with comparable-store sales down 12% from the day of reopening to the close of the quarter; TJX saw second-quarter sales decline by 31.8% with open-only comp-store sales down 3%; and Burlington sales declined by 39.2% during its second-quarter with open-only comps down 14%.

The common theme among the big three off-price retailers was the lack of in-store inventory due to supply chain disruptions and pent-up demand once stores reopened, affecting second-quarter results. The same cannot be said about CTRN. The company was working through a strategic effort to optimize its inventory levels prior to the COVID pandemic, implying excess inventory at its stores. We believe that excess inventory position was a contributor to the outperformance of CTRN during the quarter as it was able to meet strong demand.

In a way, strong pent-up demand accelerated the company’s strategy to optimize its inventory levels. Better working capital management would allow the company to chase inventory in trends it sees emerging.

CTRN ended its second quarter with inventory levels down 28.4% compared to its prior-year period, and what management calls an “extremely clean inventory position.” Strong pent-up demand coupled with well-sourced stores allowed gross margins to increase by 390 basis points during the quarter to 41.2%, helped by fewer promotions, and more inventory sold at full price.

With a lean inventory position and using data-driven insights, the company’s buying team is focusing on 5 new emerging trends it wants to capitalize on, which it has named: entertain-from-home, lounge-from-home, school-from-home, play-from-home; and gym-from-home. The company has already established new vendor relationships and is expecting these new fresh receipts to hit its stores during Q3 and Q4.

The company is also introducing a new “Pet” category in its stores, which we believe should sell well. We have seen a strong performance by companies such as Central Garden & Pet Company (CENT) and Tractor Supply (TSCO) highlighting strong demand for pet products.

What’s next and the bottom line

The company is still committed to achieving its stated goal of $1 billion in sales (from $782 million in sales achieved in FY2020) and executing its plan to increase earnings per share at a compounded annual growth rate of 20% to 25%.

While its plans look a bit optimistic, given the current environment, we believe they are plausible. First, with a better inventory position, the company can now chase trends as it sees emerging. We believe its dive into the “from home” trends should be positive for upcoming results. The bankruptcies of other retailers should give CTRN an opportunity to grab wallet share as consumers look for value.

CTRN’s target market (low-to-mid income households), in our opinion, also isolates the company from the threat of e-commerce. Reliable access to the internet would vary depending on household incomes. A CNBC article notes that fewer low-income households are shopping online than they did two years ago.

The recent run-up in price has closed the value gap for CTRN. The company currently trades at an EBITDA multiple of 12x, slightly higher than its 5-year average of 11x EBITDA.

Additionally, with a 100% reliance on its brick-and-mortar stores and no cure to the pandemic, there is a high risk that as we enter the winter season, increasing cases of infections could result in another lockdown. For now, we are staying on the sidelines waiting for more clarity.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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