How Did Dillard’s (NYSE:DDS) Share Price 10X After Covid-19

IMPORTANT: Please read the disclaimer before continuing.

In the United States, the state of Arkansas is the founding place for a mega supermart called Walmart.

What’s not known to many investors is Arkansas is also the home of an upscale American department store called Dillard’s. But it could not escape the eyes of Ted Weschler who is the current investment manager of Warren Buffett’s Berkshire Hathaway. 

On 21 October 2020, Ted Weschler disclosed he owned about 5.89% of this little-known company. Back then, the stock was trading below $40. As of 10 Feb 2022, the stock last traded at $261. 

A massive gain of over 550% within a short period of time!

Is it based on hype? What’s the story behind Dillard’s? Let’s dive in.

About Dillard’s 

Dillard’s is quite like Macy’s, Nordstrom, Burlington or Target. They sell a wide variety of products covering many categories and it has over 250 locations and 30 clearance centres. 

It was founded by the late William Dillard. Today, his sons are involved in running the business.

William Dillard II is running the company as the CEO.  

Alex Dillard is taking care of merchandise. He has over four decades of experience. 

Mike Dillard is the executive vice president. 

Many investors would deem the fashion retail sector as a tough place to invest because the tastes and preferences of customers are ever-changing. Most retail companies struggle to keep up. During a covid-19 period, retail stores were badly hit as well. 

Let’s look at the revenues of Dillard’s and see how it fared:

Q1 2020 was the quarter where Dillard’s was hit by covid-19 and several of their stores were closed. After a few quarters, in Q3 2021, Dillard’s finally returned to its pre-covid-19 revenues of approximately $1,500 million. At best, an investor would think its share price would return to its pre-covid-19 levels of $60 – 70.

That did not happen, instead, the stock had gone up to $261. If we were to measure it from covid-19, the returns were almost 10x.

How was it possible? What are we missing here? 

The Explosive Effects of Margin Expansions

To investigate, we must identify how its profit margin changed over time. 

A business that makes $100 of sales with a 5% operating profit margin makes $5.

Another same business that makes $100 of sales with a 10% operating profit makes $10.

Same business but the second business is twice as profitable because of its superior operating profit. 

If a business is twice as profitable, it should command twice the valuation hence the share price should be higher by two times.

With this understanding, let’s look at Dillard’s margins. 

Since the pandemic, its gross profit margin improved from 16.2% to 47.3%. If we were to compare with pre-pandemic margins, I will take reference from Q1 2019 which was 38.1%. 

Doing simple math, 47.3% / 38.1% – 1 = 24%. This means Dillard’s is 24% more profitable on the gross profit level. 

During this period, Alex Dillard who oversees merchandising did a few actions:

• Improved the store layout for better shopping experiences
• Stocked the appropriate goods for customers due to a tight supply c hain
• Chose good locations to avoid direct competitions 

His actions resulted in decreased markdowns and it improved the gross profit margins.

As for the operating profit margin, it improved from 7% (2019 Q1) to 17.5% (2021 Q3) because of staff optimisations. That’s an increase of 150%. This means on a $100 sale, Dillard’s is now earning $17.5 instead of $7. Massive!

CEO Dillard also mentioned the key strategy to improve its operating profit margin is to operate in profitable stores instead of having stores everywhere. 

Margin expansions answer the questions of how Dillard’s was able to improve its share price without seeing any significant growth in sales. 

Apart from that, Dillard’s was able to manage its inventory better. Combined with higher profit margins, it unlocked more free cash flow for the management.

The management understood that in an industry where it is competitive, it is wiser to not overexpand and be patient for good locations to appear. In the meantime, the management team deployed its free cash flow intelligently by buying back its shares from the open market aggressively. 

(Want to learn more about capital allocation? Read The Outsiders: Eight Unconventional CEOs)

Think about it this way… you have a pizza, and the pizza is shared by 10 people. Now, one person is being bought out by the pizza restaurant and there are 9 people left. This means, the pizza is now shared by 9 people and each person gets to eat more. 

This analogy is like a company buying back its shares. Over time, as a shareholder, your ownership percentage in the company goes up and you get to receive a bigger pie of the company’s profits. 

Within a short span of a few quarters, Dillard’s bought back 25.5% of its shares outstanding.

This means every dollar of profits is shared with lesser shareholders and each shareholder gets to own a bigger piece of the profits. This means the value of a share also goes up.

The margin expansions and a strong share buy-back policy fuelled the rise in Dillard’s share price. 

Summary

Dillard’s demonstrated that it is entirely possible for a company with zero growth in sales to enjoy huge appreciation in share price. This is achieved when operational efficiency exercises are being undertaken to improve the profit margins and the cash generated by the business is put to good use. Eg, share buyback. 

With this understanding, I also must caution that there is a certain limit to how much a company can improve its margins. Margins can be improved but there are expenses in the business you cannot escape from.

For a company to become a multi-bagger or more, it still must be able to drive top-line growth. This is why software companies deliver huge returns, they have the elements of rapid sales growth and high-profit margins.

To sum it up:

• Both gross and operating profit margin expansions will drive huge growth in earnings in a short period of time. But there’s a limit.
• Free cash flow put to good one (eg, share buy back) will create huge value for shareholders.
• For long lasting appreciation in share price, top line growth is still very important.

Currently, I am invested in a company that is attempting to fix its gross profit margin to get into a breakeven stage before growing its sales. I see two stages of share price appreciation. First, getting into a breakeven stage. Second, demonstrate growth in its business units. It’s also a riskier position in my portfolio which may not be suitable for many investors yet. Once the business fundamentals are in place, I hope to share this company soon.

Now that you read this article, learn more about how a few retail companies succeed big time by executing their own retail playbooks.