Citi Trends, Inc. (NASDAQ:CTRN)

XMFConnor (97.80) Submitted: 6/23/2011 12:51:31 PM : Start Price: $14.78 CTRN Score: -7.92

I put some real skin in the game today-- even though my CAPS is already up like 6% on this pick. I think it is just way too cheap at less than 3X EV/EBITDA, 35% market cap in net cash, and strong growth prospects. I also like how it has fared very well in the market decline today.. may indicate that most of the selling pressure is done and that this thing has already hit its trough. Many thanks to people such as TMF1000 who helped me find this idea. I thought I'd return the favor to the CAPS/ MF community by posting my own thoughts. Fool on.

While Citi Trends (CTRN) is undeniably subject to the many risks of a rapidly growing fashion retailer, at the current price, investors are more than compensated for these risks. The company is currently selling for book value, which includes 76 mm in cash (35% of market cap). Other metrics also point towards value: TEV/EBITDA: 2.68, TEV/Sales: 0.22, P/E: 10.47. These seem too cheap for a company with an excellent balance sheet, solid management, and strong growth prospects.

Background

Citi Trends operates a chain of more than 450 retail stores selling nationally recognized clothing brands aimed at a young African American customer base. The stores sit in neighborhood shopping centers in both urban and rural settings and include trendy fashion lines such as Roca Wear, Phat Farm, Baby Phat, and Apple Bottoms by Nelly. Citi Trends also carries in-house brands and offers apparel, intimates, footwear, and accessories for men, women, kids, and infants, as well as home decor.
•   Strategy: They aim to provide nationally recognized branded merchandise at discounts to department and specialty stores’ regular prices of up to 60%.
o   Their merchandise offerings are designed to appeal to the preferences of fashion conscious consumers, particularly African-Americans
o   Purchasing is controlled by a 25-plus member buying team located at our Savannah, Georgia headquarters and our buying office in New York, New York. We purchase merchandise through planned programs with vendors at reduced prices and opportunistically through close-outs, with the majority of our merchandise purchased for the current season and a limited quantity held for sale in future seasons.
o   They have purchased merchandise from approximately 1,000 vendors in the past 12 months.
o   Approximately 46% of their net sales are represented by nationally recognized brands. They also offer a wide variety of products from less recognized brands and a lesser amount representing private label products under their proprietary brands such as “Diva Blue,” “Red Ape,” “Vintage Harlem,” and “Lil Ms Hollywood.”
Strong Financial Results
•   Their niche market has been hit particularly hard the past few years, but they have still been able to grow revenue and net income every single year of their 8-year existence as a public company.
•   Their stores have generated rapid payback of investments, typically within 12 to 14 months.
•   In 2010, they began to test a new store format with the assistance of a retail design consulting firm. They opened their first new prototype store in Savannah in July 2010 and later opened five more stores with the new prototype design. The stores feature a new color palette and logo, a new layout, new fixturing, dressing room, graphics and lighting, a redesigned checkout area and an expanded footwear department. Based on the reactions from our customers and the results of the new stores, we decided to open all new stores in the new prototype format in 2011.
o   From 10-Q: “There were thirteen stores relocated or expanded since last year’s first quarter, all of which impacted comparable store sales. Sales in comparable relocated and expanded stores increased 5.4% in the first quarter of 2011, while sales in all other comparable stores decreased 7.5%.” I can see why the new stores have done better—they are pretty cool. I think these stores will continue to be successful and help them boost sales.
?   http://files.shareholder.com/downloads/CTRN/1281571083x0x405640/1a81fa71-12d7-4765-8391-9ec0b530656c/citiNew_Store_Prototype.pdf

Why the Opportunity Exists

CTRN’s stock was hammered on May 17 after it indicated EPS guidance of $1.25-$1.35 for fiscal 2011, much lower than analysts’ consensus estimate of $1.54. Also, they said same store sales should be down 1-2%, including a 1-2% increase in the last three quarters of the year. The stock fell from $21 to $17 and has now drifted down to its 52 week low just below $15.

While the guidance was disappointing, I think that the stock market overreacted for three reasons:

1)    The first quarter of 2010 made for a tough comparison since same stores sales were up 9.6%
a.   Furthermore, the company did say that same store sales should increase 1-2% in the last three quarters of the year

2)   The Store Renovations seem to be a big success
b.   As mentioned above, sales in comparable relocated and expanded stores increased 5.4% in the first quarter of 2011, while sales in all other comparable stores decreased 7.5%. While the renovations only occurred over 13 of their stores, I think that there is a good chance that the remodeling efforts continue to have this level of success and can be applied to both future store openings and their existing stores.

3)   Management seems to be taking the right steps to keep CTRN in the right direction
i.   Their CEO, David Alexander, has 30 years of retail experience including ten years with Family Dollar Stores. I think that the decision to test the new store format at the beginning of 2010 will turn out to be a great move. In addition, their brand sales did significantly worse than their non-branded sales or what they call their fashion merchandise. He plans to focus on shifting the brands in his stores, scrapping the worst sellers, and increasing exposure to the best-selling items
In short, I think that the market overreacted to one quarter to lower guidance.

While disappointing, I think it is merely a bump in the long road of growth that Citi Trends still has in front of it.

a.   The Company has 473 stores in 27 states, but about 42% of those stores are in only four states. I think that they can approximately double their store count without saturating the market. Just as a reference, there are 890 current TJ Maxx stores.
b.   The company is accelerating the rate of store growth from 60 last year to a planned 65-70 this year.
c.   It only recently launched a Facebook fan page. After 4 months, it already has over 121,000 fans: https://www.facebook.com/cititrends

•   They are currently estimating 2011 earnings per share in a range of approximately $1.25 to $1.35, which includes an assumption that comparable store sales will be up 1% to 2% in the final 3 quarters of the year. Using comp multiples on the low and high end (10-16X ttm earnings), this would result in a fair price in the range of $12.50- $21.60. This equates to $2.33 of downside risk and $6.77 of upside, or a nearly 3:1 risk/reward from the current market price.

Conclusion

The bottom line is that the market hammered Citi Trends (CTRN) after missing guidance, but there are a lot of reasons to think that this was overdone. Ignoring their large capex spend for their new distribution facility (which should last the company for the next five years), the company would have had positive FCF last year. At less than 3X EV/EBITDA, I think a lot of the potential concerns about CTRN’s future are already price into the stock, and investors get an opportunity to pick up a fast-growing, differentiated retailer with a large margin of safety.