Citi Trends’ Stock Price Already Discounts Most Future Positive Developments (NASDAQ:CTRN)

Citi Trends (NASDAQ:CTRN) is an American retailer specializing in apparel and accessories in physical stores in low-income neighborhoods.

The company received a windfall when pandemic stimulus money hit its core demographic strongly, and it became a meme stock for a while.

After the pandemic, the reverse occurred. The company’s low-income demographic is suffering from inflation and curtailing spending. Despite having more stores, the company sells less than during the pandemic.

I like the company’s value proposition and focus on a specific core customer (African American low-income mothers). The company has a strong balance sheet to weather an economic downturn. It could potentially recover sales. The company made efforts to control SG&A, albeit unsuccessfully.

However, Citi Trends’ current stock price already discounts a recovery, so the stock is not an opportunity. I believe Citi Trends is a Hold and not a Buy.

Company Introduction

Citi Trends has a straightforward value proposition: low prices, a large assortment, and simple stores for African American low to middle-income mothers.

The company’s average customer has a household income of less than $45,000, with 50% of customers earning less than $25,000.

Pre-pandemic investor presentation slides show that 90% of their customers are women and that 85% of them are African American.

Citi Trend stores are located mostly in the Southeastern states, plus near Chicago, with headquarters in Georgia and distribution centers in Oklahoma and South Carolina.

Men’s products only make up 18% of sales, with the rest being comprised of Women (26%), Kids (22%), Accessories (18%), Home (9%), and Footwear (7%), according to the company’s FY22 10-K.

As seen in the image above or many YouTube shopping vlogs, the company’s store layouts are simple, with few fixtures. Prices are very competitive, with most items in the $10 to $25 range.

Citi Trends does not advertise (less than $1 million was spent in this category in FY22), does not have an e-commerce platform, and does not offer discounts.

The company has 600 stores and about 4,500 employees.

Pandemic Boom And Bust

The stimulus money distributed during the pandemic helped the low-income demographic to which Citi Trends caters. This led to an explosion in revenues and consequent margin expansion, reaching 8% operating margins.

Unfortunately, stimulus money was not infinite, and eventually, inflation started ravaging CERN’s customer’s income. Inflation always hits poorer people harder because they do not have financial assets, generally pay rent, and have less in-demand jobs with lower bargaining power. Inflation was especially hard this time in non-discretionary items like gas and food.

The consequent fall in gross margins was expected, as apparel retail suffers from operational leverage both ways (stores and employees cannot be adjusted on par with demand).

However, just like with recently covered Tilly’s (TLYS), I am surprised to the extent that inflation has hit Citi Trends’ revenues. The company sells less than before the pandemic despite having 7% more stores. It probably indicates that the company is having trouble attracting customers on top of the macroeconomic headwinds.

Also, similar to Tilly’s, the company’s operating margins are much lower than before the pandemic, even with similar sales.

The SG&A Problem

As shown in the above section, the company was profitable in 2016, 2017, 2018, and 2019, with revenues that are similar to today’s.

Why is it now showing operational losses? The reason is sticky SG&A expenses. Despite having the same level of revenues, Citi Trends’ TTM SG&A is $32 million higher than in FY19.

One portion is store rent. Citi Trends records lease expenses in SG&A. These amounted to $71 million in FY22, compared with $58 million in FY19. This represents a $13 million increase, $6 million of which comes from the sale and leaseback of its two distribution centers.

More importantly, store employee salaries have gone up. In FY19, the company had 5,700 employees, compared to 4,800 in FY22. That is an improvement, considering Citi Trends has 606 stores as of 3Q23 versus 574 in FY19.

However, according to the company’s proxy statements for FY22 and FY19, the median employee compensation was $16 thousand in 2019 versus $25 thousand in 2022. Despite the decrease in headcount, the company is now paying almost $30 million more in wages than it did in 2019.

This indicates that management is working to improve its efficiency via fewer workers for more stores, but that the increase in labor costs is more than offsetting this effort.

Valuation and expectations

Citi Trends trades today at a market cap of $255 million and an EV of $190 million (probably closer to $165 million after 4Q23 results because inventories become cash).

The company’s gross margins for 3Q23 are already in the pre-pandemic range of about 38%. With SG&A of $280 million (very sticky), the company needs to make $740 million to break even. This indicates that if the company can arrest the revenue fall, it should be able to breakeven operationally in 2024.

In the pessimistic scenario, the company would probably need to finance losses and close stores if revenues keep falling. Fortunately, it has $60 million in cash as of 3Q23 and likely as much as $85/90 million by 4Q23 (post-Holidays). This is almost half of the discounted lease liabilities of the company.

On the other hand, to generate a 10% earnings yield on the above EV of $160 million, considering 30% in income taxes and 38% gross margins, the company should post revenues of $800 million, or 8% above the current level.

This doesn’t seem very easy, given the current context. Further, suppose the company’s stock yields a decent return only under the optimistic scenario but not the current or a pessimistic one. In that case, it is probably not a good opportunity at these prices.

Further, it is not that Citi Trends was a fantastic business pre-pandemic, with only moderate growth rates and average returns on assets.

For that reason, I believe Citi Trends’ stock is not an opportunity today, although I will continue to follow the name.