Dillard's stock taking major hit

LITTLE ROCK, Ark. -- Shares of Dillard's Inc., the No. 5 U.S. department-store company, fell 20 percent Friday amid declining sales and rising costs at former Mercantile locations being converted into Dillard's stores.

Dillard's fell 5 13/16 to 23 11/16, its biggest one-day decline in at least 19 years. The company operates stores at Las Vegas-area regional malls.

The company said earnings in the quarter ended July 31 rose less than expected as sales at Mercantile stores acquired a year ago dropped 19 percent. Profit this quarter also will be limited by Dillard's costs to clear out Mercantile's brands of clothes and other goods.

"They're trying to fit the Mercantile stores into the Dillard's mold, and I don't think it's working," said portfolio manager Donald Brown of the Ohio Public Employees Retirement System, which owns Dillard's shares.

Dillard's last August paid $3.14 billion for Mercantile -- whose stores included J.B. White, Joslins, Gayfers and Maison Blanche -- to expand in the southern and midwestern U.S. The Little Rock, Ark.-based retailer sold some of the stores, including 15 to Saks Inc., to eliminate overlap in some markets.

Saks, which owns the Saks Fifth Avenue chain, also said last week that sales at its Mercantile locations were running 20 percent below expectations and hurting its earnings.

"I think there are a lot of senior executives in the retail industry right now that wish they never heard of Mercantile," analyst Wayne Hood of Prudential Securities said.

So far this year, shares of Dillard's and Saks have fallen 17 percent and 43 percent, respectively, ranking them the worst-performing stocks among big department stores.

Dillard's fiscal second-quarter net income fell 24 percent to $36.2 million, or 34 cents a share, from $47.9 million, or 45 cents, a year earlier. The results fell short of the average estimate of 48 cents from analysts polled by First Call Corp.

It operated 336 stores in 29 states as of Aug. 5.

Dillard's has been implementing at the Mercantile stores its policy of offering consistent prices on clothing and home goods. That's a change from Mercantile, which held periodic promotions that promised steep discounts.

"Dillard's is not promotional and neither is Saks," Hood said. That makes it difficult to gauge demand at the former Mercantile stores, he said.

At the same time, the retailer added sales staff, eliminated Mercantile's private brands on goods such as clothing and slashed prices on products it no longer planned to carry, so that it could restock shelves with its own merchandise.

"We just couldn't sell the goods for a profit" at Mercantile, Chief Executive William Dillard II said on a conference call. "We had a lot of various Mercantile private-label goods. We were shocked at how much of it there was."

The moves cost Dillard's more than expected, and hurt sales while shoppers adjusted to the changes in the stores.

"The customer is totally confused by going into a Mercantile store with a new format," Ohio Public Employees' Brown said.

Selling, general and administrative expenses in the Mercantile locations were 27.2 percent of sales compared with 23.9 percent in the rest of its chain.

The former Mercantile stores also contributed about $25 million less to gross margins, which measure how profitable each sale is, than the other Dillard's stores, the company said.

In the quarter, Dillard's revenue rose 26 percent to $1.96 billion from $1.55 billion, while sales at stores open at least a year rose 4 percent.

The changes that Dillard's is making to its merchandise aren't expected to revive sales and profit until the fiscal fourth quarter, the company said.

The company, criticized by investors and analysts on its conference call for not being forthcoming enough about its business, refused to provide specific guidance on second-half earnings or expenses.

Prudential's Hood cut his rating on Dillard's shares to "hold" from "strong buy," and reduced his full-year earnings estimate to $2.65 from $2.95 a share.

Dillard's is expected to earn 53 cents a share in the fiscal third quarter and $1.31 in the fourth, the average forecasts of analysts polled by First Call.

The stock will probably bounce back to between $27 and $29, and remain there until early next year, when Dillard's reports fiscal fourth-quarter earnings, Hood said.

CEO Dillard said the retailer considers its stock to be cheap after Friday's drop, and it will look into buying back shares when its board meets Saturday.

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