Cato's Dividend Yield Is the Cat's Meow, but for How Long?

 | Jul 12, 2017 | 11:00 AM EDT
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When it comes to dividend yield, if a yield seems too good to be true, it probably is. The market has a way of telling us when it believes that condition to be the case; it simply pushes a given stock's price down, forcing the indicated yield up. The problem is, dividend yield is backward-looking, as many fundamental metrics are. As someone in the industry once told me, using fundamentals alone is a bit like navigating a car while looking in the rear-view mirror. That's an important lesson, especially for we value investors.

Last summer, when private prison operator CoreCivic Inc. (CXW) (known as Corrections Corp. of America at that time) hit the skids after the U.S. Department of Justice threw cold water on the private corrections industry, the stock's yield shot up to more than 16%. Given that CXW is a REIT that pays out most of its earnings in the form of dividends, it was clear that a dividend cut was coming. To buy the stock at that point solely for its yield was pure madness. Indeed, the company cut the quarterly dividend 22%, from 54 cents to 42 cents. The stock would take a hit, but since then has recovered nicely and currently yields 6.2%.

One current situation I have my eye on is fashion retailer Cato Corp. (CATO) , a double-net (company trading at between one and two times net current asset value) that operates 1,374 stores in 33 states. I am generally not a fan of retail, especially in the current environment dominated by Amazon (AMZN) , but this stock is intriguing at the very least.

Cato's stock has been crushed. It's down 44% year to date, following down years in 2016 (off 15%) and 2015 (down 10%).The recent news also has not been good; June same-store sales were down 16%. In addition, the company has not taken advantage of the growth in online shopping and generates very little in online revenue.

Despite competing in a tough business, Cato currently pays a 33-cent quarterly dividend, which produces a yield of a whopping 8.2%. Considering all that's wrong with this company and with bricks-and-mortar retail in general, you'd generally have to conclude that a dividend cut is on the way unless Cato somehow can right the ship.

The interesting thing about Cato, however, is that it is flush with liquidity and ended last quarter with $231 million, or nearly $9 per share, in cash and short-term investments and no debt. That's a number that may be fleeting, especially if results continue to deteriorate, but it should provide a runway for the company to try and fix itself, though that won't be easy.

In the end, there are two ways to view Cato: 1) a dinosaur and value trap that has seen better days and will continue to deteriorate as brick-and-mortar continues to decline and a company that ultimately will need to cut its dividend as losses mount and cash is burned, or 2) a cash-rich value play that trades at 1.9 times net current asset value. The belief under the second scenario is that while Cato has significant challenges, they already seem priced into the stock; the thinking here is that the stock has been overly punished and that the company will be able to maintain its current dividend payout.

I remain on the fence at this point. One thing to note is that just one analyst covers the company, so it is far from a household name. The current estimate for next year's earnings is $1.45 a share, which puts the forward price-to-earnings ratio at 11. Keep in mind, that earnings estimate has been revised downward from $1.69 a share and should be monitored. Interestingly, the company has beaten earnings expectations (or should I say expectation) in 10 of the past 11 quarters.

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