Stage Stores: Robust Growth At Discount Prices

Stage Stores (SSI) is an owner-operator of discount retail stores across the country under brand names Steeles, Goodys, Bealls, Peebles, Palais Royal and Stage. The company sells moderately priced brand name and private label merchandise in family apparel, footwear, cosmetics, accessories and home décor through its various retail channels. The company operates over 860 stores total and also offers its goods through its website. The stock recently hit an all-time high of nearly $30 but has since pulled back sharply to trade below $23. After such a violent pullback the question for investors is whether the pullback was warranted or not. I'll argue in this article that the pullback in Stage Stores was a gift to long-term, value investors and that this pullback should be bought as SSI's position in its industry remains strong.

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In order to figure out what SSI is worth, it is instructive to understand what analysts think of the company's earnings prospects. I'll use these and other inputs in my discounted cash flow model in order to determine a fair value for SSI shares today.

Before we can understand the output of the model, however, we need to understand the inputs. First, I lifted analyst earnings estimates for 2013 and 2014, book value and earnings growth rates from Yahoo! Finance. Dividend growth rate is assumed to be 15% per annum, per SSI's propensity in recent years to drastically increase its dividend. Discount rate is assumed to be 9.5% and perpetual growth rate is assumed to be 3%. Both of those are my estimates and as such, you may not agree but there is some inherent subjectivity involved in making such forecasts.

This model is a different take on the DCF model for forecasting and discounting earnings. Basically, with the inputs described above, the model shows what the company's economic earnings are worth over the time period described. The! company's ultimate value is based upon its ability to create shareholder value (book value) and to earn an economic profit based upon that book value. The model's output shows us the value the company is creating above and beyond its economic cost of capital.

Speaking of that, I chose 9.5% as the cost of capital for this model. Basically, the way I think of the cost of capital for this model is by determining an acceptable annual rate of return. The cost of capital is a "tax" of sorts in the model wherein the cost of capital is multiplied by the company's book value to get the "normal" earnings you see below. The "abnormal" portion of earnings is the amount of value the company is creating above and beyond its economic cost of capital, as described above. The idea, of course, is to have as much in the abnormal earnings row as possible as that implies the company is creating economic value with its asset base. These abnormal earnings are then discounted back to the present based upon the cost of capital rate used to derive a present value.

!

	2013	2014	2015	2016	2017	2018	2019
Earnings Forecast
Reported earnings per share	$1.47		$1.72	$1.93	$2.17	$2.43	$2.73
x(1+Forecasted earnings growth)		17.01%	12.25%	12.25%	12.25%	12.25%	12.25%
=Forecasted earnings per share		$1.72	$1.93	$2.17	$2.43	$2.73	$3.07
	!	!
Equity Book Value Forecasts
Equity book value at beginning of year		$14.24	$15.39	$16.65	$18.06	$19.62	$21.34
Earnings per share		$1.72	$1.93	$2.17	$2.43	$2.73	$3.07
-Dividends per share	$0.50	$0.58	$0.66	$0.76	$0.87	$1.01	$1.16
=Equity book value at end of year	$14.24	$15.39	$16.65	$18.06	$19.62	$21.34	$23.25
Abnormal earnings
Equity book value at begin of year		$14.24	$15.39	$16.65	$18.06	$19.62	$21.34
x Equity cost of capital	9.50%	9.50%	9.50%	9.50%	9.50%	9.50%	9.50%
=Normal earnings		$1.35	$1.46	$1.58	$1.72	$1.86	$2.03
Forecasted EPS		$1.72	$1.93	$2.17	$2.43	$2.73	$3.07
-Normal earnings		$1.35	$1.46	$1.58	$1.72	$1.86	$2.03
=Abnormal earnings		$0.37	$0.47	$0.59	$0.72	$0.87	$1.04
Valuation
Future abnormal earnings		$0.37	$0.47	$0.59	$0.72	$0.87	$1.04
x discount factor(0.095)		0.913	0.834	0.762	0.696	0.635	0.580
=Abnormal earnings disc to present		$0.34	$0.39	$0.45	$0.50	$0.55	$0.60
Abnormal earnings in year +6							$1.04
Assumed long-term growth rate							3.00%
Value of terminal year							$15.96
	&! nbsp;
Estimated share price
Sum of discounted AE over horizon		$2.22
+PV of terminal year AE		$9.26
=PV of all AE		$11.48
+Current equity book value		$14.24
=Estimated current share price		$25.72

As you can see, given the inputs I discussed, SSI's fair value today is closer to $26 per share than $23. This implies a margin of safety on the current price of almost 13%. It is important to understand exactly what this model says as well. In essence, the output says that, at a 9.5% discount rate, SSI's future earnings combined with shareholders' equity mean the company is a good buy below $25.72 in today's dollars. Therefore, the market is offering you SSI shares at 13% below their intrinsic value today based upon future earnings. Not only are shares undervalued, but you are getting a market-average dividend of just over 2% to pay you while you wait. Also, given the fact that SSI is growing same store sales at a low single digit rate and continuing to open new stores and focus on its ecommerce business, additional revenue and operating leverage means that earnings could very well grow more quickly than analysts think.

In addition, it ! is import! ant to understand that $25.72 is not a nominal price target. Rather, that is the discounted present value of its future earnings and shareholders' equity. Therefore, if we simply apply the current forward earnings multiple of 13 (which I believe is too low, given SSI's earnings growth), we get a nominal price target for 2019 of about $40. However, as SSI begins to fire on all cylinders again and meets or beats its full year EPS target, the company's earnings multiple should expand once more to 15 or 16. This would imply a 2019 price target of $46 to $49. The point is that SSI's valuation is currently at a trough and as such, the material movement is likely to be to the upside as most of the pessimism that can be priced into the stock likely already is. SSI is not a high-flying growth stock that is going to increase by 5 or 10 times but it is a solid leader in its niche and is very profitable and can make you money in the process if you are patient.

So why is the market discounting SSI shares? An earnings miss earlier this year has likely shaken the investing community's confidence in SSI's ability to execute. The first quarter's earnings report was a bit ugly with sizable misses in both revenue and EPS. The stock traded down over 10% in subsequent days on heavy volume as investors digested the report. Since then, SSI shares have failed to mount a rally as the company hasn't reported earnings since that time and no other catalysts have emerged. If there is one bit of solace longs can enjoy it is that shares appear to have stabilized in the $22 to $23 area. This could be the potential springboard for further gains once earnings pick up again. Importantly, the company, despite its earnings miss, reaffirmed full year guidance for EPS and stated that comparable store sales growth should come in around 2% to 4% while raising its dividend to 12.5 cents per quarter from 10 cents.

SSI serves the discount to mid-market family demographic which is enormous and has only grown since the financial crisis.! The comp! any's stores have recognizable names and sell national brand items at discounted prices in order to fulfill the lower-to-middle market consumer's needs. Given that company sells mostly soft goods such as apparel and footwear, its demographic is virtually assured by the shift that has come about in consumer preferences since the most recession scarred consumers and raised the national savings rate and the fact that the goods that SSI sells wear out and must be replaced periodically. It is this shift in consumer preferences and needs that benefits SSI as its brands all serve that type of consumer and I believe this is why SSI's profitability, and stock price, have grown and why they will continue to grow.

The market is offering you a gift by discounting SSI shares based upon one quarter that missed expectations. This has happened before and will likely happen again but SSI is in a very strong position with its retail portfolio and will continue to be. It serves a huge and growing number of consumers that want value for their money and it does so very well. With further growth plans for its brands and the fact that SSI is a very efficient operator already, significant upside is likely in the stock. Of course, there will be missteps along the way, as we saw with first quarter earnings, but these should be embraced as long as the fundamental long-term story is intact. Until such time, enjoy the dividend and consider reinvesting your payouts in more shares.

Source: Stage Stores: Robust Growth At Discount Prices

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SSI over the next 72 hours. 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. (More...)