Tilly’s, Inc. $TLYS

My Investment Checklist

1.      Is the company undervalued?

EV/EBIT: 2.10 (Please note this excludes operating leases)

EV/Sales: 0.15

Price/Book: 1.22

$TLYS is trading at a valuation that would make the great depression look like a walk in the park.  Having said that the business is most likely over earning, with sales and profits expected to contract over the next 12 months.  Nevertheless Mr. Market has priced this company for dead, even with ample runway left to increase their store count and a massive net cash position.  Furthermore $TLYS is a free cash flow machine and returning most of that capital back via special dividends and buybacks.  Given the valuation it’s nearly impossible to believe this stock is priced appropriately.  

2.      Can I easily explain what the company does?

Yes, they’re an apparel retailer headquartered in California.  $TLYS currently has 241 stores and an e-commerce website. 

3.      Does the cash flow statement line up with income statement?

No, reported income has been a touch higher than cashflow from operations:

Although changes in accounts payable and inventories more than makes up for this discrepancy.  Other than that; most of Tilly’s cash went towards special dividends, capital expenditures, and share repurchases.  These all seem like a sensible use of capital.   

4.      Is the Balance Sheet Healthy?

Total Cash: $116.38M (this includes marketable securities)

Total Debt: $198.27M

Current Ratio: 1.59

You might be asking; Eric didn’t you just say $TLYS has a net cash position?  Indeed, I did.  $197.75M of their total debt comes from operating lease obligations.  Because leases are expensed quarterly on the income statement, they should not be capitalized on the balance sheet too.  It’s double counting and one of the dumbest accounting rules IMO.  Therefore once you back those numbers out Tilly’s is sitting on a ~$116M net cash position, giving them a Fortress Balance Sheet!!!

5.      How profitable is the business?

Gross Margins: 44.4%

Operating Margins: 7.2%

Net Margins: 5.2%

Retailers typically have thin margins and $TLYS is no exception.  In fact earnings are almost certainly overstated looking at the trailing 12 month data:

As you can see $TLYS is not a good business (probably a shitco if I’m being honest).  However this is a game of handicapping and the lowest operating margin $TLYS posted (excluding the Covid year) was 3.3% in the last 10 years.  That’s roughly a 54% drop off from their current margin profile, but again the company is trading for 2X EBIT!!!!!

6.      What is the company’s growth potential?

10-yr Revenue CAGR: 6.8%                                                    

10-yr Operating Profit CAGR: 11%

10-yr FCF CAGR: 18.71%

The end date used here was exceptionally good year, so it would be wise to take these numbers with a grain of salt.  Nonetheless management believes they can open at least 10 new stores annually for the foreseeable future and intuitively I would anticipate some organic growth from e-commerce, which makes up ~18.5% of sales.  Frankly this company is not a melting ice cube, yes sales may be down YOY in 2023 but mid-single digit growth long term is more than achievable:

7.      Is management rewarding shareholders?

Tilly’s has a history of paying out special dividends essentially ever year since 2017 and are authorized to buyback ~1M shares by March 2023 (weird that it’s based off shares and not a dollar amount).  Nevertheless this company is no doubt shareholder friendly, returning ~$35M on net back to shareholders over the last 4 years.  That works out to ~16% shareholder yield relative to their market cap and mind bending 31% shareholder yield relative to enterprise value.  Moreover management seems to understand capital allocation:

“Matt Koranda (Analyst)

Okay. Excellent. Maybe just last one. It looks like you guys were willing to sort of buy back shares at an average of $9 a share, if I just do the rough math in terms of the calculations here. And the stock is now in the low 7s. It just seems maybe like the logical conclusion here that we should have is that you'd be more willing to transact on the buyback versus special dividends at the moment. But any thoughts you'd like to opine on that front would be helpful.

Michael Henry (CFO)

That's a fair assumption. We've been pretty strategic about it as we saw our business slowing down. In second quarter, we unfortunately had the fourth thought that, okay, well, we've completed almost half the buyback at an average price that was $9.10, and given what we're seeing, it's likely that the stock could probably go down based on how things are slowing down. So we did pause for a little bit. I wouldn't be surprised if we took some opportunistic situations to get back into that program.”

I almost never seen management teams this thoughtful in regards to buybacks, which you simply love to see!  My only gripe would be that Tilly’s should be leaning into share repurchases harder.  With a $213M market cap and $116M in cash, Tilly’s could easily buyback 25% of outstanding shares and still have a great balance sheet.

8.      How does the company stack up against their peers?

The closest competitor to Tilly’s is probably Shoe Carnival Inc. $SCVL:

EV/EBIT: 3.21

EV/Sales: 0.41

Operating Margin: 13%

$SCVL is less cheap than $TLYS, although it’s historically been more profitable and both have grown at more or less the same rate.  $TLYS wins by default here as it’s substantially cheaper and likely to see a shallower drop in profit margins.

9.      What’s the counter argument?

The counter argument is that retail is about to get crushed due to bloated inventories as we head into a recession.

              I don’t disagree with this statement, but you’d be hard pressed to argue that this  isn’t already reflected in the share price.  Moreover Tilly’s inventory situation is relative strong compared to other retailers.  For instance inventories are only up ~3.5% YOY, which is effectively a rounding error.  This coupled with an elite balance sheet leads me to believe that $TLYS will be able to weather whatever macroeconomic storm lies ahead.  

10.  Is there something I think the market may be missing?

I literally have no clue why $TLYS is trading so cheap.  They’ve proven to be better operators over the last few quarters and have zero solvency concerns.  My only guess would be that it’s an unknown name (I was unaware of the business prior to this write-up) and the sector is almost certainly going to post negative comps for the next few quarters.  Furthermore Tilly’s valuation is being reported incorrectly on damn near every finance platform.  For example Yahoo is showing an enterprise value of $347M, whereas in actuality is closer to $110M.  That is a massive delta, which investors would be none the wiser to if they failed to read Tilly’s investor communications.

Final Thoughts:

              $TLYS is bad business in a historically bad industry, but the stock is currently defying the laws of logic.  My base case would be as follows; 4% topline growth annually for the next 5 years with a 4.5% operating margin in year 5.  I would also expect at 12% net shareholder yield annually with an 8X EV/EBIT exit multiple at the end of 5 years.  That works out to an absurd ~35.5% expected annual return!!!  Personally speaking I’m sitting on an uncomfortable amount of unrealized losses in retail names and I think $TLYS makes a whole lot of sense to tax loss harvest into.  With that said I wouldn’t size the position over 5%, because it’s a no moat company which I have zero competitive advantage in.  Finally please do not base your investment decisions off my analysis, as I’ve been ice cold lately. 

***Disclosure: I have no position in the security mentioned above, nor do I have any plans to purchase within the next 72 hours.  This article is intended for educational purposes only and in no way should be interpreted as investment advice