Put Dillard's in Your Stocking

 | Nov 17, 2011 | 10:15 AM EST
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I've been looking at retail plays this week as we head into the holidays. With a market capitalization of just $2.5 billion, investors rarely mention department-store chain Dillard's (DDS).

Actually, I take that back. Somebody must be talking about the Little Rock, Ark., company because its stock is up more than 28% year to date. By comparison, Macy's (M) is up about 20% and Kohl's (KSS) is basically flat. Dillard's was taken to the woodshed in mid-August when it missed expectations. If the stock wasn't hit, it would have been up more than 40%.

Has Dillard's been unfairly punished? And if so, is this stock a better way to play the holidays than Macy's and Kohl's?

In August, Dillard's reported adjusted earnings per share of $0.32, which missed most forecasts of $0.50. Analyst rushed to adjust their financial models and cut their ratings. While the company may have missed the Street's expectations, the July quarter was very strong. Quarterly profit doubled, helped by higher sales. Net income more than doubled to $17.6 million. And sales at stores open at least a year rose 6%, while overall revenues rose 4% to $1.4 billion. Gross margin was flat at 33.7%.

But as the year has gone on, same-store sales have picked up -- after all, that's what pushed the stock up 40% until August. If you go back to the March quarter, the company reported an ugly negative 1% comparison in both February and March. By April, same-store sales were up 11% vs. last year's 5% decline.  After the April report, everybody upgraded the stock. The analysts cited improving store trends, a stock buyback, more full-priced selling, the company shutting unproductive stores and effective inventory controls as factors for lifting their ratings. July same-store sales rose 6%. Then, in August, gross margins were slightly less than expected, and the stock fell $8.

Despite the tough retail environment, Dillard's is having its second-strongest same-store sales momentum in a decade. Shouldn't that at least carry through the holidays? November's same-store sales were up 5%. Gross margin was flat at 36.8%, so Dillard's hasn't been juicing up the numbers with big price cuts. Analysts are expecting margins to weaken into next year, so they have become cautious on the stock.

But it seems most retailers have figured out how to compete in this environment and build store traffic. I believe Dillard's can hold the line on margins for another quarter and beat the Street. Since only three analysts cover the company, there is a wide variation in estimates for the full year, ranging from $4.10 to $4.22 per share. With such a wide range, how can Dillard's miss?

To me, Dillard's will be a high-$50 stock (or 10 to 15%) by December. If Dillard's can keep the momentum going, it should be a nice holiday gift for your portfolio.

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