Investment Thesis
Citi Trends (NASDAQ:CTRN), a specialty apparel value-priced retailer, has compelling competitive advantages that its new leadership team is leveraging for substantial earnings growth. CTRN is a rare specialty retailer that serves an underserved niche, African American and Hispanic families. Investors underappreciate the significant earnings growth potential of this retailer's turnaround strategies, while focusing instead on misperceived challenging comparisons for next year. New management is transforming operations to modernize merchandising strategies and logistics, with new processes and technology. With stronger profitability, CTRN has resumed its regional-to-national store expansion and launched a remodeling campaign for existing stores. With a debt-free balance sheet and at least high-teen EPS growth for the foreseeable future, CTRN shares are undervalued at less than 10x our F2022 EPS estimate. Our 12-month price target of $107, represents 37% upside (base case), while our bull case of $137 and bear case of $59 illustrate the asymmetric risk/reward profile.
Company Overview
Citi Trends is a leading specialty value retailer catering primarily to African-American and Hispanic families and merchandising apparel, accessories, and home goods. This retailer operates 602 stores in 33 states.
New Management Leading Transformation
Citi Trends rebuilt its management team and embarked on a turnaround strategy, following a two-year activist shareholder campaign with Macellum Capital Management that resulted in new board leadership and the subsequent resignation of its chief executive officer in June 2019. Macellum had argued that long-tenured board members, ineffective management, merchandising miscues, and outdated IT systems led to years of underperformance.
Peter Sachse, one of the first directors to join after this campaign, was later named interim CEO and is currently executive chairman of the board. In our view, he has been instrumental in developing and implementing the turnaround strategy. Sachse is a 34-year veteran of Macy's (M), having served in a variety of senior roles, including most recently as Chief Growth Officer after Chief Stores Officer, Chief Marketing Officer, and chairman and CEO of the macys.com division.
David Makuen became CEO in March 2020, having been recruited from Five Below (FIVE) where he had been Executive Vice President, Marketing & E-commerce. Given his 8 years at FIVE, we think Makuen was an up-and-coming leader in the industry, especially the value retail niche.
Pamela Edwards has served as CFO since January 2021. Her prior experience includes various CFO positions at L Brands during 15 years, including its Mast Global, Victoria's Secret, and Express divisions. We think Edwards provides CTRN with solid financial management capabilities, given her blue-chip experience with major retail brands.
Lisa Powell, chief merchandising officer, joined CTRN in September 2019, soon after the activist campaign settled. Powell previously served in senior merchandising roles at other off-price apparel stores, including Century 21 Department Stores, Saks Off Fifth, and The TJX Companies (TJX). We think Powell brought merchandising management discipline and best practices to Citi Trends.
We believe that assessing management credibility is an underrated part of the investment research process by most investors. Therefore, we have chosen to highlight this much improved leadership team.
Source: Citi Trends investor presentation (April 2021)
Compelling Competitive Advantages
In addition to disciplined and credible leadership, we find core competitive advantages compelling for the Citi Trends concept. In our view, these competitive advantages provide the foundation for management to execute its growth strategy.
Similar to Shoe Carnival (SCVL), a retailer on which we recently wrote an extensive article titled "A Cinderella Reopening Play With 25% Upside," Citi Trends serves an underserved customer base and benefits from strong loyalty. CTRN primarily serves African-American families and secondarily Hispanic families, which collectively comprise 84% of customers. The average household income for customers is $38,000, and 88% of customers have household incomes below $50,000. Further, 55% of customers are between 25 and 40 years-old.
Source: Citi Trends investor presentation (April 2021)
The loyalty of CTRN customers is evidenced by 21% of customers shopping the store weekly and another 25% every other week. In addition, 47% of customers spend 30 to 60 minutes shopping per visit, while another 16% spend between 1 and 2 hours, resulting in 63% of customers spending at least 30 minutes per trip. We think this loyalty has been cultivated not only by the focus on these underserved demographics but also by stores being strategically located within neighborhood shopping centers as a one-stop shop for the entire family. More than 50% of customers live within 10 minutes of a store.
Source: Citi Trends investor presentation (April 2021)
CTRN's new store economic model is among the best in the retail industry, resulting in another clear competitive advantage. These stores have an annual return on investment of 50%, and therefore the new store payback period is only two years.
Source: Citi Trends investor presentation (April 2021)
Growth Strategy
The new strategy for CTRN to grow sales and earnings rely on these key initiatives:
- Grow Store Base
- Optimize Merchandise Mix
- Investment In Infrastructure
Grow Store Base
Given management believes the Citi Trends concept can grow to 1,000 stores nationally and there are roughly 600 open today, there is nearly 70% potential store fleet growth remaining. This is realistic and compelling, when considering the current store map, as well as the new strategy to open stores focused in "melting pot" neighborhoods for African-American and Hispanic families, as well as Hispanic-centric neighborhoods. For example, as the current store map illustrates, there are many states in the Southwest where Citi Trends can significantly grow its store base. There are currently approximately 95 and 66 stores already in "melting pot" and Hispanic-centric neighborhoods, respectively.
Source: Citi Trends investor presentation (April 2021)
In our view, new store expansion needs to be managed carefully. This is especially true, when entering new markets and catering to new demographics. Proper consideration for real estate, marketing, and store/ regional management are critical. As a result, we think management's goal to open 100 more stores through fiscal 2023 is prudent, which amounts to roughly 5% annual new store growth. Based on the success of these openings, we think CTRN may accelerate store openings after fiscal 2023. Earlier in this retailer's history, new store growth was too fast, having doubled the base from 235 in fiscal 2005 to 461 in 2010. As a result, new store openings slowed considerably during the past decade.
From a real estate strategy perspective, Citi Trends prefers to locate stores in the center of communities. As a result, typical co-tenants are supermarkets, such as Kroger (KR) and Save A Lot, value retailers, such as Big Lots (BIG) and Ollie's (OLLI), wellness retailers, such as Planet Fitness (PLNT) and Sally Beauty (SBH), and dollar stores, such as Dollar Tree (NASDAQ:DLTR) and Dollar General (DG).
In addition to accelerating new store openings, Citi Trends is just as focused on remodeling existing stores. These remodels have new signage, layout, and simply a bolder, contemporary appearance. As a result, these stores have higher conversion and productivity.
Optimize Merchandise Mix
Citi Trends historically poorly managed its inventory, especially on a per store basis. This fundamental weakness was part of the foundation for the previously discussed settled shareholder activist campaign. CTRN is transforming its buying, planning, and allocation teams with fact-based optimization processes. Comparable store inventory declined by 40% to $107,000 enabling store inventory turns to increase by 24% to 5.2, in fiscal 2020.
CTRN leadership introduced several new processes, which meet best practices for retail management. Buyers are tasked with curating assortments by brand, focusing on trend right and fresh fashion. In addition, the merchandising team prioritizes choice and breadth over depth, which aligns with the strategies of other "off-price" retailers, such as ROST and TJX. In addition, Citi Trends has expanded its assortments in non-apparel categories, such as home, lifestyle, beauty, and accessories. These new merchandise areas generate higher margins and turnover.
Source: Citi Trends investor presentation (April 2021)
According to the most recent 10-K filing, Citi Trends merchandise mix by category has remained fairly stable over the past few years. For fiscal 2020 as a percent of total sales, women's generated 26%, kids 23%, men's 18%, accessories & beauty 16%, home & lifestyle 9%, and footwear 8%.
Investments In Infrastructure
Citi Trends under prior leadership had been very slow to modernize its technology, which we think was part of the root causes for this retailer's underperformance for much of the past decade. This is finally changing now. For example, the buying, planning, and allocation teams are now equipped with cloud-based software and analytics. In addition, distribution centers have upgraded technology and systems which are likely to generate increase supply chain speed and productivity. This type of speed is very important, since part of the overall growth strategy is to inject newness into stores more frequently and that requires quicker processing times within distribution centers and shipping to stores. At the store level, CTRN is investing in a new point-of-sale system and workflow apps that will improve store management. Therefore, these new investments effectively improve systems for buying, transporting, and selling merchandise.
Competitive Analysis
Citi Trends most closely competes against other value-priced apparel retailers, including Walmart (WMT), Target (TGT), The TJX Companies (TJX), and Ross Stores (ROST). WMT and TGT are big box retailers that lack a specialty store experience, with limited customer service and only a few national brands. When compared to the various store banners under TJX, such as T.J. Maxx and Marshalls, and under ROST, such as Ross Dress For Less and dd's DISCOUNTS, CTRN differentiates itself with a smaller store size (average 11,000 square feet), a more welcoming store design (including carpeted flooring and aspirational in-store signage), higher levels of customer service, broad assortments of the popular national brands, and perhaps, most importantly, a clear focus on its underserved customer niche, African American and Hispanic families. As a result, the value proposition that Citi Trends offers its core customers is overwhelming, especially when considering the average unit retail price is approximately $8.50.
Recent Performance & Financial Position
Citi Trends reported continued strong performance and raised full-year guidance, when announcing 3Q:F2021 results last month. Even more impressive than the comparisons to the same period in fiscal 2020 were results relative to the same period in fiscal 2019, pre-pandemic.
Same-store sales increased 13.1% year over year, representing the ninth consecutive quarter of comp growth (excluding closed stores). When compared to the same period in fiscal 2019, same-store sales jumped 19.7%, gross margin expanded by 290 basis points to 40.3%, and operating margin grew by 600 basis points from (0.9%) to 5.1%. In our view, these two-year results clearly demonstrate Citi Trends is successfully transforming itself for higher sales and profits.
Underscoring leadership's confidence in the business, CTRN authorized an additional $30 million share repurchase program on top of the $8 million remaining on its existing program.
The balance sheet is debt-free, aided by strong free cash flow. At the end of 3Q:F2021, Citi Trends held $47.5 million in cash and short-term investments. For the first nine months of fiscal 2021, CTRN generated $34 million in free cash flow (operating cash flow minus capital expenditures).
While management plans to detail its "long-range Citi Master Plan" in January at the ICR Conference, CTRN issued big picture guidance for low-to-mid single digit annual sales growth with at least low double-digit EPS growth. With plans to accelerate new store openings and remodels (40 new store and 40 remodels in fiscal 2022), we think the sales outlook is likely conservative, when considering new stores and same-store sales growth.
Financial Model
Source: The Bulls Bay estimates
We model high single digit sales growth in fiscal years 2022 and 2023, based on our assumptions that annual square footage growth will be in the mid-single digits and same-store sales will growth in the low single digits. Despite "difficult" comparisons to fiscal 2021 in fiscal 2022, we think the continued economic reopening from the pandemic will lead to comp growth. We anticipate margin expansion, as stronger inventory management and logistics efficiency spark 20 to 40 basis points of annual operating margin improvement.
With strong annual free cash flow, we also expect Citi Trends to repurchase shares during the next couple of years, albeit perhaps at a slower pace than in prior years. We anticipate an average of 350,000 shares to be repurchased each year. This follows the repurchasing of more than 25% of the company's shares since the end of fiscal 2019.
Valuation
Source: The Bulls Bay estimates
When choosing the comparable company set for valuation purposes, we used a different group from the key competitors set. Whereas competitors are the retailers for which Citi Trends shares customers and merchandising, the valuation comparable group are specialty apparel retailers with a similar market capitalization and store fleet size. Based on this valuation analysis, CTRN trades at an average P/E multiple, despite significantly higher expected earnings growth. As a result, we suggest that CTRN deserves a stronger valuation multiple and assign a 13x multiple, which corresponds to the estimated two-year average net income growth in fiscal 2022 and 2023. Our $107 price target is based on a 13x multiple to our fiscal 2022 EPS estimate of $8.23 and yields 37% upside.
Our bear case is predicated on same-store sales declining in 2022 and therefore operating margin erosion, due to deleveraging of fixed-costs. Under this scenario, CTRN would be re-rated lower with multiple contraction to 8x. As a result, our bear case price target is $59, representing 24% downside. Our bull case assumes that same-store sales are better-than-expected and reach high single digits, leading to stronger gross margin and operating margin expansion. If this were to occur, CTRN would be re-rated higher with a 15x multiple. Our bull case price target is $131, implying 68% upside.
Source: The Bulls Bay estimates
Catalysts
2021 Holiday Sales Pre-Announcement
Citi Trends plans to present at the ICR Conference in early January 2022. Most retailers that present at this conference pre-announce holiday sales and/or update full-year guidance. This is exactly what CTRN did in January 2021 before presenting at this annual conference. As such, we think a key catalyst would be better-than-expected holiday sales and therefore another upward revision to full-year guidance. Retail stocks have been especially volatile in recent weeks, as investors appears conflicted between two extremes: fears that the omicron variant will dampen holiday sales contrasted with predictions that this year's holiday sales will set a record.
Citi Master Plan
In tandem with a 2021 holiday sales pre-announcement, management plans to detail its revised "Citi Master Plan." This is essentially a multi-year growth plan. Since 2021 greatly exceeded expectations with very high growth rates (i.e., EPS more than tripling), investors are anticipating this new long-term guidance, which has the potential to instill greater investor confidence in the sustainability of earnings growth.
Quarterly Dividend Reinstatement
Citi Trends suspended its $0.08 quarterly dividend in March 2020 due to the onset of the COVID-19 pandemic. While the board of directors has resumed and accelerated share repurchases since then, the dividend remains suspended. We think these decisions were likely the result of capital allocation prioritization, as well as a recognition of the significantly depressed valuation of CTRN shares during the past two years. We suggest that during the next two years plus, CTRN is likely to reinstate its quarterly dividend and begin emphasizing the dividend over share repurchases.
Risks
Child Tax Credit Elimination
The possible elimination of the child tax credit may put additional financial pressure on low-income families who are the core customers for Citi Trends. However, even if this were to occur, we think the overall health of consumers would remain relatively strong. Even if some customers scaled back purchasing, then other consumers may "trade down" and become new customers for Citi Trends, given the value proposition.
Prolonged Inflation
If the current inflation trend remains into the second half 2022, we think there could be additional financial pressure on customers. However, this pressure may be offset by higher wage growth.
Fashion Miscues
We suggest the most significant risk is fashion. With more than 25% of sales generated by women's apparel, we think this share underscores the importance of trend right fashion and proper balance within assortments and brands. In order to consistently meet this challenge, CTRN has significantly enhanced its buying, planning, and allocation teams with new technologies and software.
Conclusion
Citi Trends is a rapidly growing specialty apparel retailer with a new leadership team, following a successful activist shareholder campaign. The new team is overhauling the business, reigniting new store openings, remodeling stores, and investing in technology to support and modernize merchandising and logistics. CTRN benefits from a debt-free balance sheet and strong free cash generation, which is utilized in part for share repurchases. With expectations for at least high-teens earnings per share growth over the next couple of years and its stock trading at less than 10x our F2022 EPS estimate, we think shares are undervalued. At 13x our F2022 EPS estimate of $8.23, we think CTRN shares will trade at $107 over the next 12 months, representing 37% upside. We anticipate investor confidence will be strengthened in early January, when the company pre-announces 2021 holiday sales and updates investors on its multi-year growth plan. With our bear case implying 24% downside to $59 and bull case implying 68% upside to $131, we believe there is a compelling asymmetric risk/reward profile.
The Bulls Bay
The Bulls Bay is the founder and portfolio manager of a family office. Previously, he was a sell-side equity research analyst covering consumer/retail and later a senior analyst at a long/short, special situations hedge fund. He is particularly attracted to value, deep value, and special situations equities across industries, while specializing in consumer/retail. In addition, The Bulls Bay sells covered calls as an opportunistic options strategy.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of CTRN either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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