Cato Corp. Is Still a Good Catch

I first recommended Cato Corp. back in June of 2020, when Covid-related store closures were devastating most non-essential retailers. The debt-free company was losing money for the first time, had suspended previously generous dividends and had plunged from an all-time peak north of $44 to south of $7. If you owned Cato already, you were hurting. If you hadn't looked at it before, you probably just moved on to other stocks, which appeared more promising. Why did I spotlight it then? CATO was selling for a fraction of its old prices and at a major discount to its book value. The company had proven earnings power of $1.40 to $2, which was likely to reemerge once pandemic-related closures were removed. CATO's typical price-to-earnings back then was about 15-times. A simple regression to a slightly below-the-mean valuation on $1.50 in earnings per share suggested a $21 price target over the coming 12- to 18-months. As things turned out, Cato's fiscal 2021 came in even better than hoped for, at $1.65. The shares cooperated, reaching a peak of $19.89 during November 2021. The ugly duckling shares had risen by greater than 185%. Dividends were reinstated in the second quarter of last year at 11 cents and were quickly raised 54.5%, to a 17-cent rate three months later. Further increases appear likely before long. There has been no bad news since, yet as of April 13 of this year, CATO was offered for just $14.60, while yielding 4.66%. The formatting in the chart below shows that Value Line relegated CATO from its main research universe to its small-cap edition, which receives no analyst inputs. The same is now true with coverage from Yahoo Finance. They post data and news but now have zero analyst estimates for CATO on their site. Ditto for FastGraphs. I've found over my 43-years of doing this, that orphaned companies are often mispriced due to lack of analyst interest. That can provide excellent profit potential, if you can establish a clear idea of what those stocks are really worth. I'm guessing that CATO can up its fiscal 2022 EPS by about 9%, to $1.80. If so, a simple regression to the mean valuation could send the shares to north of $27.50 within a year. That's a pretty good move from $14.60 plus almost 5% in current yield while you wait. CATO's debt-free status and high corporate cash balance gives the shares a much safer profile than might be expected. As of Jan. 29, 2022 the company held almost $8 per share in cash, about 55% of the current quote. Net out that cash component and you're getting around $1.80 in EPS on an equity base of under $7. That implies plenty of room for dividend increases and/or continuing share buybacks. Option-savvy traders can pocket excellent premiums for selling Oct. 21, 2022 naked puts at $12.50 to $17.50. Worst-case, if exercised prices dropped to between $11.50 and $13.70 providing decent downside protection from today's already good price. Even the most aggressive of those break-even prices is below the lows dating back to May of 2021 when a large positive fiscal Q1 earnings surprise sent the shares rocketing higher. Regular readers know my penchant for setting up buy/write combinations on stocks I love. Here were the numbers on a 1,000-share, 10-covered call plus 10-naked put, $15 strike price comb out to Oct. 21, 2022. If CATO merely rises at least 2.8% from its present quote and holds $15 on expiration day the following best-case scenario will play out. The mechanics of the trades would morph even a very modest rise into a 46.1% total return in just over six months. What if CATO fails to reach and hold $15? Barring a major, unexpected, collapse even that would appear far from scary. Combination sellers would end up with double-sized positions in CATO, but at an average net cost of just $12.58 per share. Any decline of less than 13.8% from the trade inception price would allow for immediate liquidation for at least a small, and perhaps a still substantial profit if CATO remains not far below $15. There you have it. CATO is a fine, well-run company paying a marking beating yield while offering significant upside potential. The fact that nobody is paying much attention to CATO right now is probably the only reason it's so cheap currently. Buy some shares, sell some puts or consider going with full buy/write combinations.

Cato Corp. Is Still a Good Catch

Let's revisit an old favorite I recommended in the early months of the pandemic -- and still looks good.

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