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Retail’s Biggest Cash Machines

The retail sector is a cash machine, unlike most businesses that tend to dry up cash reserves on overhead.

The retail sector is a cash machine, unlike most businesses that tend to dry up cash reserves on overhead.

And the ability to generate cash is the elixir that has attracted private equity firms. Leveraged buyouts are easily structured because of a retailer’s cash flow. Although not all retail businesses are the same, inventory and store openings can sap net cash in a hurry.

WWD calculated the cash-to-sales ratio of the top apparel retailers in the industry and found that slightly less than half had ratios greater than 100 percent, meaning their rate of cash generation outpaced their sales for the trailing 12-month period.

Of the 55 publicly traded retailers tracked by WWD, 24 had cash-to-sales ratios in excess of 100 percent, and 18 of those had ratios exceeding 200 percent. Thirteen retailers had ratios between 5 and 100 percent. Eighteen had negative cash flow.

The cash-to-sales ratio is a metric used by some analysts to compare the cash generation of companies. Its value is in comparing one company’s ratio to another.

Guess, The Wet Seal Inc., Buckle Inc. and Tiffany & Co. topped the list of strong cash generators, with ratios of 561, 498, 484 and 433 percent, respectively. The average cash-to-sales ratio of all the companies was 211 percent.

The retailers with low ratios or negative cash flow tended to be companies such as American Eagle Outfitters Inc., Abercrombie & Fitch Co. and Kohl’s Corp. — businesses that are spending their cash on expansion or repositioning.

Christine Chen, equity research analyst at Needham & Co. LLC, said most analysts and investors tend to look at free cash flow per share, but that there is value in compiling cash-to-sales ratios. “Not many people in the industry look at it this way, but it does tell you how much cash these retailers are throwing off,” Chen said.

The results were surprising, she said. “Some [companies] you would think would come out on top, like American Eagle, did not,” Chen said. “Capital expenditures has a big influence on results.”

Chen added that Guess’ strong cash generation reflects the success of the company in Europe, as well as with its wholesale business.

This story first appeared in the June 29, 2007 issue of WWD.  Subscribe Today.

Eric Beder, senior vice president at Brean Murray Carret & Co., said it was important to also look at the companies that deliver high gross margin rates, which would explain why the top cash generators tend to be specialty retailers.

“Specialty retailers do more full-price selling when they have the right fashion than a lot of the department stores or mass merchants,” Beder said. “Most specialty retailers have a higher average sales per square foot and most have their own network and do their own manufacturing and designing, which drives higher margins. Specialty retailers also have the ability to control cash flows by monitoring how much they spend to make product and how much they will charge for their product.”

Guess and Wet Seal are retailers that “have a high focus on minimizing inventory,” Beder said. “A chunk of money for apparel retailers is spent on inventory rather than in store development and rollouts. A big focus for these retailers is managing inventory to drive higher margins.”

Beder and Chen said cash flow is determined by inventories and new store openings. “If a retailer is ramping up store rollouts a lot quicker, they will feel that in their cash flow, which could explain American Eagle and Abercrombie,” Beder said. “When companies stop opening new stores, it opens cash flow.”

Craig Johnson, president of Customer Growth Partners, a retail consulting firm, said examining cash flow is a “better tool than same-store sales,” but it is not always indicative of a company’s retail performance.

From an investor’s point of view, looking at cash flow has value because smarter companies will use cash to gobble up outstanding shares, which then drives up the earnings per share growth.

“Free cash flow is often undervalued by the investment community,” Manny Weintraub, who heads Integre Advisors, said in a report this week. “But it is an excellent way to invest in growth, while protecting the downside.”

Weintraub said there are public companies investors can target that “generate a lot of free cash flow. So after capital expenditures, there’s a lot of money left over, which can be used to either buy shares or buy competitors. And I think that is a very healthy thing to have, especially in this environment where people can also use that free cash flow to [make a leveraged buyout of] a company or buy in a company.”

Weintraub said there are “unpopular” public companies in the market now that “can muscle their earnings up; they can grow their earnings per share by shrinking the share count. So even if there is some sort of challenge in the business, presumably temporary or cyclical, they are able to grow earnings per share anyway. And that’s actually the worst-case scenario that they’re able to grow by muscling their earnings forward. The best-case scenario is that free cash flow is discovered by an acquirer.”