Reitmans: A Canadian Dividend Powerhouse Feels Fashion's Sting

09/07/2012 7:30 am EST

Focus: GLOBAL

John Heinzl

Reporter and Columnist, GlobeInvestor.com

Despite its lush yield, Reitmans' stock has gone out of style. Blame that on falling sales and the imminent arrival of Target, writes John Heinzl, reporter and columnist for Globe Investor.

Tempted by Reitmans' (Toronto: RET.A) juicy dividend yield? To make money with this stock, you'll need plenty of patience—and a bit of luck.

Once a reliable dividend grower, the Montreal-based company hasn't raised its quarterly payment since 2010. Its sales and profits are dropping. And the arrival of Target (TGT) next year is threatening to make life even more difficult for the women's clothing retailer, which is feeling the brunt of a sluggish economy, high fuel and food costs, and tough competition.

For the second quarter ended July 28, Reitmans' sales fell 2.3% to $279.5 million, and same-store sales slipped 1.7%. Reflecting the drop in sales and lower gross margins, profit skidded 12.5% to $27.7 million or 42 cents a share—missing analyst estimates.

And nobody expects things to turn around soon.

In its second-quarter press release on August 29, Reitmans disclosed that same-store sales for the four weeks ended August 25 plunged 8.1%, hurt by previously announced problems with a new warehouse management system, which caused temporary disruptions in the flow of merchandise to stores.

Reitmans said the problems have been resolved, but warned that "the issues...will have an adverse impact on sales and margins for the third quarter."

Given Reitmans' myriad challenges, some investors have given up on the stock. Shares of the company, whose retail banners include Reitmans, Smart Set, RW & Co., Penningtons, and Addition Elle, are down about 16% in 2012, excluding dividends. Since July 2010, they've plummeted about 38%, closing Tuesday at $12.44 on the Toronto Stock Exchange.

Yet for patient investors, some analysts think the beaten-down shares are a good value. In recent notes, RBC Dominion Securities analyst Tal Woolley—who rates the stock "outperform" with an $18 price target—listed several reasons that he still likes Reitmans:

The 6.4% dividend yield is supported by solid free cash flow and a hefty cash balance of about $3.50 to $4 a share, giving the company plenty of financial flexibility for share buybacks or acquisitions.

The depressed shares "are discounting very pessimistic long-term scenarios," so any signs of recovery would be expected to have a positive impact on the stock. The company generates above-average returns on invested capital and has a history of making smart big-ticket investments and responding well to competitive threats.

The shares are cheap, trading at about 13 times estimated fiscal 2013 earnings, compared with a market-weighted average of 14.7 times for a basket of US clothing retailers.

The company could make an attractive takeover target. "Given the net cash on the company's balance sheet, its low-cost operating network and no budding family 'dynasty' within management, we believe a sale transaction is possible at attractive terms for all shareholders," Woolley wrote in a July 12 note.

Not everyone is as enthusiastic about Reitmans' prospects. Two other analysts who follow the company both rate the stock the equivalent of a "hold," with an average price target of $13.25.

John Morris of BMO Capital Markets, who has a 12-month target of $13, said the stock's "current valuation adequately reflects the company's near-term prospects and risks," and said it is "difficult to make a case for improved consumer spending in an uncertain economic environment."

But, he added, Reitmans remains "one of Canada's best-positioned apparel retailers" thanks to its solid management team, well-known retail brands, and diversified lineup of stores that limits its exposure to any single niche.

Bottom line: Reitmans' rich dividend is safe, but don't count on any increases until earnings improve. A recovery in Reitmans' fortunes isn't certain, however, given the sluggish economy and growing competition from Target and other retailers.

So while any sign of a turnaround would probably drive the stock higher, risk-averse investors might wish to look elsewhere.

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