Fundamentals
Much like for JWN, we expect a snap back in apparel/accessories that are the core of what DDS sells. That is dressier or somewhat more formal wear for work, an evening out, or special occasions that clearly happened at a significantly reduced rate in 2020 with Covid. The exact timing of the full ‘reopening’ is a moving target for now, but we are modeling demand to start to ramp to almost 2019 levels around mid 2021. The street looks a little low on both revenue and margins, moreso on the latter. We’re coming in around $6.25 for ’21 -- considerably above the street at $2.27. We expect gross margin upside with strong full price sell through with leaner inventories and lapping the big compression here in ’20. DDS has some credit exposure (high margin), the street is expecting it to be down slightly in ’21 after a big drop in ’20, that seems fair and more realistic than the recovery to 2019 levels expected for the likes of KSS. 4Q20 could be squirrely as we’re modeling a miss given the street is expecting a big 1000bps comp acceleration, while most of retail has shown some slowdowns in 4Q amid rising Covid cases. With that said, the market is likely to look past 4Q performance caring more about what ’21 will look like. DDS has low debt levels, with notes trading well above par, and no maturities of size for the foreseeable future with $45mm due in 2023 and $96mm due in 2026. With $6.25 in earnings, one might ask should DDS trade much above a low double digit multiple? Well the interesting element here is cash flow. DDS owns about 90% of its square footage, so occupancy falls within D&A vs rent expense. So with $6.25 in EPS, add back D&A and some working capital help (~$50mm) lapping Covid and we’re looking at almost $14 per share in FCF, then another $12.40 per share in ‘22.
The Trade
We think there is a good chance for this stock to trade up closer to low to mid-teens FCF yield on our cash flow number. JWN is down to 7.5% consensus NTM FCF, KSS (where we see expectations as high) is at about a 19% yield on consensus numbers. Low to mid-teens FCF yield would mean a stock of $90-$100. There is a chance for a much higher price however given the trading dynamics here. DDS is run almost as a pseudo private company by the founding family. The company has 22.3mm diluted shares outstanding. The official float from Factset is 71.3%, with the family and other insiders owning ~29%. About another 35% is owned by the employee share program (Newport Trust Co as the Administrator). Index funds are another 10% +/-. So when you boil it down you have ~25-30% of the float that would be “actively” traded. That’s about 6.5mm shares. The current short interest is 4.4mm shares, or about 2/3 of that “adjusted” float. The current borrow cost of ~25% confirms this pressure on being short. Then you have to factor in that the company consistently buys back stock proven by the fact that it has been buying back in 2020 despite the business disruption. It also has a small dividend. Given our cash flow expectation, depending on market price, the company could buyback 3-5mm shares this year alone. At a minimum that buyback support means the stock is not likely to trade down. If combining buyback with some short covering as the fundamentals prove to be well above street expectations, it’s fair to think the stock could double or more as it struggles to have as many sellers as buyers barring the family/insiders unloading stock.
