2 Retail Stocks With 50%-Plus Upside
When it comes to retail stocks, the macro picture covers everything.
Slow consumer sales are restraining growth, and until consumers feel perkier, sector share prices are likely to only slowly merge from their current malaise. Yet in any given year, you can find a handful of retailers that have clear catalysts to deliver robust upside.
A pair stands out for the year ahead, as each carries more than 50% potential upside.
| 1. Destination XL Group (Nasdaq: DXLG ) |
 You may know this company by its former name, Casual Male. Management decided to change the name a year ago to better reflect this retailer’s focus on extra-large men, also known as the “big and tall” crowd. Most retailers carry only a limited assortment of menswear catering to this demographic, making Destination XL the industry’s only pure-play on this niche. The slow economy over the past five years has surely impacted results for this company. Annual sales, which used to exceed $450 million before the Great Recession, now hover around $400 million. While awaiting a better economy, management has done a great job of managing inventories. Gross margins have risen for five straight years, as this retailer has managed to avoid sharp markdowns at the end of each season to clear out the merchandise. #-ad_banner-#More importantly, management is implementing a storewide revamp which should eventually aid operating margins as well. Low-traffic locations, operating under the Casual Male name and typically found in strip malls, are slowly being closed, and are being replaced by larger stores, known as Destination XL, in higher-traffic areas. Sales at the new larger stores are rising at a double-digit pace. The older Casual Male stores are slowly being closed, which is offsetting sales growth for now. The process is roughly half complete. By 2015, management expects to operate 225 Destination XL stores (up from four in 2010 and 99 in 2013). Apparel makers are pitching in as well. Brands such as Brooks Brothers, Adidas (OTC: ADDYY), True Religion Apparel (Nasdaq: TRLG) and others are now making more products in large sizes for sale at the Destination XL stores. Lake Street Capital’s Mark Argento thinks the move will reap solid returns: “The new DXL store format is a substantial upgrade from the Casual Male store as it’s much larger, has better locations, and is more up to date in terms of layout and product assortment. We believe the DXL format is more attractive to the younger, more brand conscious customers which tend to skew younger and tend to spend more money on their clothes.” By his math, the company controls just 11% of this $3.5 billion to $4 billion market, and the revamping of the store base should lead to gains in market share. (J.C. Penney (NYSE: JCP) and Sears Holdings (Nasdaq: SHLD) are the only major retailers focusing on this niche.) Shares have been under pressure lately as management recently announced plans to open just 40 new Destination XL stores in the current fiscal year, down from prior plans of 60. The goal is to focus on the best real estate opportunities that are opening up. The slower transition also means that full-year profits won’t come before fiscal 2016.
When this process is complete, shares should trade at up to 1 times sales (on an enterprise value basis), which equates to around $9, or more than 50% above current levels. Improved levels of consumer spending would add upside to that target. At least one major investor sees solid upside ahead. Will Mesdag, who runs Red Mountain Capital Partners and already owned nearly 10% of the company when the year began, has picked up more than $6 million in stock in March. |
| 2. Bon-Ton Stores (Nasdaq: BONT ) |
 This operator of roughly 270 department stores has seen better days. Annual sales, which reached roughly $3.5 billion in fiscal 2008, now sit below $3 billion. Adding insult, Bon-Ton has lost money in each of the past three years. Nearly a month ago, CEO Brendan Hoffman announced plans to leave the company, realizing perhaps that his efforts to improve results were simply not paying off.
Paradoxically, his departure is welcome news. In the absence of a current CEO, Chairman Thomas Grumbacher is in control. Grumbacher, who owns nearly 1 million shares, is 75 years old and likely has little appetite to assume day-to-day operations. The easier path might simply to find a buyer for the company, which currently trades for a quite reasonable 4 times trailing earnings before interest, taxes, depreciation, and amortization (EBITDA). Analyst David Glick, who follows Bon-Ton for Buckingham Research, notes that while shares are undervalued based on the fundamentals, “There is a compelling strategic and financial rationale to consider it as a viable takeout candidate.” His $18 target price represents nearly 70% upside. He suggests department store operator Belk as a potential acquirer, while hedge fund manager (and CNBC pundit) Doug Kass thinks Dillard’s (NYSE: DDS) would find shares appealing. Clearly, by several metrics, this is a deep value play, making even J.C. Penney look comparatively pricey.
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Risks to Consider: Both of these retailers would benefit from an improved retail spending environment, which would lift investor sentiment toward the entire retail sector. If retail spending remains in a funk, these stocks are unlikely to post major gains in the near term.
Action to Take –> These are two distinct turnaround opportunities, and you should decide if you prefer a struggling retailer (Bon-Ton) that has become a deep value stock, or a transformational turnaround (at Destination XL) that could help the retailer to become a category killer.
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