Retailing is a very tough industry to invest in and one that I typically avoid. With the exception of ultra-luxury retailers that have unique attributes, retailers generally have a low barrier to entry. But consumers make purchases every day, and even in this economy, one segment of the retailing industry is experiencing strong growth in both sales and profitability.
Not surprisingly, I am talking about the ultra-discount retailers. Names such as Dollar General (DG) and Family Dollar (FDO), which offer basic everyday goods, often at $1 or less, are appealing to vast array of U.S. consumers. Shopping at these names has become a choice for higher-income Americans, not just financially strapped households. Over the past decade, Dollar General has seen its sales and profits soar while the ultimate low price giant, Wal-Mart (WMT), continues to struggle for consistent positive sales growth. Dollar General now has more stores than all of Wal-Mart combined.
Then you have the fashion discount retailers such as TJX (TJX) and Stein Mart (SMRT), which offer designer label merchandise at discount prices. No need to delve deeper as to why such a business might be doing very well today.
I recently discovered the small-cap retailer Gordmans Stores (GMAN), a company that started in 1915 in Omaha but went public in 2008. Gordmans is a discount retailer offering "60% off everything," and it has 74 stores in 14 Midwestern states where competitors such as TJX and Stein Mart have a relatively small footprint. The company's business model is simple: Offer prices that are lower than even the lowest prices at specialty and department stores.
The company has a strong growth curve ahead of it: Management has a goal of increasing its store count by 10% each year for the foreseeable future. What makes Gordmans different is that it takes the best aspects of specialty stores, department stores, big-box retailers and discount retailers and combines them under one roof. Gordmans can offer the lowest prices because it buys directly from vendors without vendor rebates. By forgoing this common element in retailing, Gordmans gets the best possible pricing. The company buys from nearly 1,000 different vendors, so it does not rely on just a handful of suppliers. Stores are bigger than your typical TJ Maxx or Stein Mart, so they can offer a wider selection of merchandise.
Currently, Gordmans' shares trade for $17, or a market cap of $330 million. Since the company went public, annual sales have grown from $463 million in 2009 to over $550 million in 2011. Net profit has jumped from $16 million to over $25 million during the same time. The company has about $40 million in cash and less than $1 million in debt on the balance sheet. With equity $77 million, Gordmans effectively generated a 35% unlevered return on equity in 2011.
Given management's growth initiatives and the strong unit economics of a retail store, Gordmans' profits are likely to continue growing at a nice clip for several years to come. Shares trade at 13x trailing earnings and 10x forward earnings for a company whose profits are growing by 25% on an annual basis. And given the strong demand for quality discount retailers, the opportunity for future growth is very ripe today. Since Gordmans' earnings are likely to double again in the next three years, its shares could be among the best-performing of the little-known retailers for years to come.