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A Look at Cato Corporation (CATO)

Disclosures / Disclaimers

  • This post is only for informational/educational purposes. Cognitive Quant provides a due-diligence platform and is not a recommendation service / newsletter

  • We have a position in CATO - however, it should not serve as a positive/negative consideration as we may add/reduce/exit at our discretion. Please conduct your own due-diligence prior to investing your valuable capital


  • CATO, a low-price apparel retailer, has recently had a few challenging years. However, it still has a strong balance sheet with NO debt and sells at < 0.5 book value and even below its net cash position of $5.51

  • In addition, it has significant hidden land assets whose worth is currently not being taken into consideration by the market

  • We believe that a currently undisclosed land transaction will likely bring the value of CATO's land assets back into the market's consideration when it appears in the upcoming quarter's 10-Q filing, potentially acting as a short-term catalyst

  • The primary risk is that prolonged challenges in the underlying business (and perhaps the onset of a recession) could reduce CATO's net cash position. This might prompt the management to cut its hefty dividend (~13% yield currently), which could exert further downward pressure on its share price

Introduction / Discovery

The Cato Corporation (CATO) was founded in 1946 and is a low-price retailer that operates around 1200 stores primarily in the southeastern United States. It operates stores under the names “Cato”, “Cato Fashions”, “CatoPlus”, “It’s Fashion”, “It’s Fashion Metro”, and “Versona” primarily in strip shopping malls anchored by national discounters such as Walmart.

CATO began as a family-owned business and went public initially in 1968, then was taken private in 1980 and subsequently returned to the public markets in 1987. For the most part, CATO has been run in a very fiscally conservative manner after it came close to bankruptcy in the early 1990s. Since then, despite being part of a very cyclical industry, it has been one of the few apparel retailers that had positive earnings through the recessions in 2001, 2007-2009, and multiple apparel retail slowdowns between 2011 and 2019.

However, since the pandemic, CATO has had only one profitable year as it has struggled with multiple issues over time (supply chain, inventory management, merchandising, inflation). That said, CATO still has a very strong balance sheet with $5.51 per share in net cash, while its share price closed at $5.33 prior to this article's publishing. In non-OTC US markets, businesses selling below net cash typically tend to be early-stage biotech firms with substantial expected R&D expenses and uncertain futures or non-US (typically China) domiciled small-cap firms.

As such, it was surprising to see CATO come up in the following custom screener on our platform, which looks for firms selling below net cash, with extremely low bankruptcy risk (using the Z-score metric) and fraud risk (using the Beneish M-score metric):

Cognitive Quant Custom Screener


Our interest in CATO is purely from a deep value perspective - it is not what we would consider a high-quality company but it is also not a cigar-butt business in that it is not in a declining industry and its balance sheet should help it recover from what appears to be a temporary/cyclical slump. In our view, it represents an extremely mispriced opportunity that we are willing to wait for the market to recognize (and it is possible that we may not have to wait for long).

A quick-look at the checklist below shows CATO has a strong balance sheet, and even with the inclusion of operating leases, the Net Debt/Equity ratio is < 50%.

CATO Checklist

For this discussion, we will ignore the consideration of the return measures (ROA, ROE, etc., which are not ideal) as our interest in CATO, as previously mentioned, lies in what we perceive as its mispricing. As such, we will focus on considering if CATO has the financial resources to meet its current obligations. Given that CATO has no debt, the primary consideration will be about its operating leases.

Source: CATO Operating Lease Disclosure in 10-K for FY ending Feb 2, 2024
Source: CATO Operating Lease Disclosure in 10-K for FY ending Feb 2, 2024

As seen on the right, the weighted average remaining lease term is 2.3 years and this gives CATO considerable flexibility in managing its business should it take longer to turnaround the retail business. Further, using the weighted-average discount above of 4.58% and the PV of lease above, we are looking at an approximate imputed interest of ~ $7 M which can be easily covered by the CATO's ~$107 M in cash and short-term investments for an extended period.

So even though CATO is priced as if it is going out of business soon, we can be reasonably sure that it is not likely to happen (at least not in the near-term).


Why this obvious mispricing?

Why does such an obvious anomaly exist with the amount of computational capacity directed toward discovering undervalued firms? It is hard to know for sure, but here are a few potential reasons:

  1. With the adoption of ASC 842 (FASB's accounting lease standard), many otherwise well-capitalized apparel retail firms started scoring adversely on Altman's Z-score that assesses bankruptcy risk. Additionally, the debt/equity metrics also appear to be inflated because operating leases are now on the balance sheet. As a result, some of the popular websites have CATO's Z-score near the distressed spectrum (which could result in quant screens/quants ignoring them for their elevated bankruptcy risk). Cognitive Quant uses xBRL operating lease disclosure data to make appropriate adjustments - as can be seen in our checklist above, CATO is currently not at any risk of bankruptcy. Please note that we are not suggesting that operating leases should be ignored - quite the contrary. However, it is important to remember that the Z-score coefficients and score guidelines were developed during a period when operating leases were not included in the balance sheet.

  2. CATO did not perform well in its 2023 Q4 results - with negative net income and cash flow from operations. Given that most apparel retailers generate bulk of their annual profits in Q4, many investors may anticipate CATO having an even worse Q1 given its adverse results in Q4. However, unlike most retailers, CATO typically performs better in Q1 and Q2 (especially Q2). In fact, over the last ~30 years, CATO has only once had negative earnings in Q1 (Q1 2020). Please note we are not asserting that CATO is definitely going to be profitable in Q1 2024, but that historically, it has tended to be profitable in Q1.

  3. Perhaps the most likely reason for this mispricing is that CATO's valuable land assets are buried within 'Other Assets' in its financial disclosures (more on this in the next section). Much of this land was purchased around 2015 and is recorded at its purchase price on the balance sheet, which is substantially less than its current worth in our assessment.



Let's first start with the assets that are most liquid and least uncertain, namely, cash and short-term investments:

CATO Cash and Short-term Investments

CATO closed at $5.33 the previous day. Investing at this price essentially means acquiring a viable business for free, with very little likelihood of risk to one's principal.

Let's continue to assume that the apparel business holds no value and examine the assets buried in the 'Other Assets' disclosure in its 10-K.

CATO Other Assets
Source: CATO Other Assets Disclosure in 10-K for FY ending Feb 2, 2024

'Land held for investments' constitutes the largest percentage of assets disclosed under 'Other Assets'. CATO owns approximately 300 acres of land, and potentially more, as it ceased reporting land holdings designated for investments in 2016. It currently reports only the acreage of land used/intended for operational purposes. It is important to note that we will be excluding 'Deferred Compensation Investments' in our valuation assessment as there is a corresponding liability.

In its 10-K for fiscal year ended January 31, 2015, the company made the following declaration (emphasis is ours):

Item 2. Properties: The Company’s distribution center and general offices are located in a Company-owned building of approximately 552,000 square feet located on a 15-acre tract in Charlotte, North Carolina. The Company’s automated merchandise handling and distribution activities occupy approximately 418,000 square feet of this building and its general offices and corporate training center are located in the remaining 134,000 square feet. A building of approximately 24,000 square feet located on a 2-acre tract adjacent to the Company’s existing location is used for receiving and distribution of store and office operating supplies. The Company also owns approximately 326 acres in York County, South Carolina, just south of Charlotte.

In its 10-K for fiscal year ended January 31, 2021, the company made the following declaration (emphasis is ours):

During 2020, the Company recorded a gain on the sale of land held for investment of $2.3 million within Interest and other income on the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss).

This land was recorded at $900,000 within 'Other Assets', this implies that the land was sold for $3.2 million, i.e., greater than 3x its recorded book value. Given the passage of time, we believe many market participants have likely forgotten about this transaction and, as such, are probably overlooking the value of this hidden asset.

In any case, we anticipate a reminder in the 10-Q for the upcoming 2024-Q1 quarter when CATO discloses a more recent transaction that took place in February 2024. We stumbled upon this transaction while combing through land transaction records to gain a better understanding of the current value of CATO's land holdings. In this transaction, CATO sold approximately 30 acres of land for $4.2 million in proceeds. Based on our review of land records, we estimate this land is likely recorded in 'Other Assets' at a book value of around $1 million, suggesting it was sold for approximately 4x its recorded book value.

Here is a snippet from The Herald a local newspaper in case you do not want to rummage through the land records to verify the above transaction:

Tri Pointe Homes out of Charlotte bought 30 acres beside the former Knights Stadium site in Fort Mill for $4.2 million. Cato Land Development sold the Deerfield Drive property on Feb. 16. The land is just north of where the baseball stadium once stood, and south of Springfield Parkway.

Incorporating insights from above into our valuation, we can see that there is a comfortable margin of safety even at book value consideration for assets recorded in 'Other Assets'.

CATO Cash + ST Investments + Other Assets

Finally, let's consider CATO's apparel business. In the last 10 years, it has earned a median diluted EPS of $1.46 and even if this declines further to a normalized EPS of $1, at 8x PE (vs Median PE across 10 years of ~13), the apparel business would be worth $8 per share.

CATO Diluted EPS: 2008 - 2024

Essentially, we are looking at a business very conservatively worth around $14 with additional assurance/certainty provided by (at a minimum) $6.36 in cash and other valuable assets. In addition, CATO owns additional buildings and properties, parts of which may not be essential to its operations, such as the approximately 185 acres of land in South Carolina designated as a potential new site for its distribution center. These assets could also be partially or fully monetized to extract additional value.


Likely Catalysts & Risks

CATO is likely to release its Q1 earnings next week and when they disclose the terms of the land transaction (described above) that took place in February, 2024 - it may serve to remind investors regarding the value of its overlooked land assets buried in its financial disclosures. This could help correct at least some of the current mispricing.

Another potential catalyst could be an eventual perceived/real improvement in its business, particularly since Q1 and Q2 are typically stronger quarters for CATO from a seasonal perspective. However, it may take a while for the value of the apparel business to be fully reflected in the share price, especially if the company continues to struggle with inflation and merchandising issues.

Apparel retail is a challenging industry with high fixed costs, and in the event of a recession, management might decide to curtail/eliminate the currently substantial dividend (around 13%) to conserve cash, which could exert further downward pressure on its share price.

Investors should also bear in mind that CATO is a "controlled corporation" as John P.D. Cato beneficially owns ~52% of the combined voting power (and ~15% of its shares) and his interests may differ substantially from those of other minority investors.


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