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Value Leaders: ANN Inc. (ANN) has weathered retail downturn well, private equity firm takes stake ANN Inc. (ANN), which was just added to the Value Leaders Rankings this week, is a women's apparel retailer that we think has an attractive risk/reward at current levels. Their recent results have not been great in terms of growth but ANN has weathered the downturn better than most retailers. We also like that the LOFT banner is doing especially well and we like that management is focusing on that segment in terms of store openings in 2014.
There has been some big news lately that gapped the stock higher in mid-March. Golden Gate Capital announced a 9.5% stake in ANN. We already liked the story but the vote of confidence from a private equity firm known for its success in the retail sector was a nice development to see.
There are clearly risks as the consumer spending environment is still weak and the retail environment is still highly promotional. As much as we like ANN, the company is not immune from what's going on in its industry. They did announce a realignment recently which will save $25 million per year but its margins are still thin. Nonetheless, we like the risk/reward here in light of the attractive valuation, the Golden Gate purchase and the strong performance of ANN's LOFT segment.
What They Do
ANN is a retailer of upscale women's clothing, shoes, and accessories designed exclusively for its Ann Taylor and LOFT stores. The Ann Taylor brand targets fashion-conscious career women while the LOFT brand provides more affordable, casual apparel for younger women. The Ann Taylor brand competes in the affordable luxury price category while LOFT, which was launched in 1996, competes in the "upper-moderate" price category.
ANN currently operates 1,025 stores, comprised as follows: 268 Ann Taylor stores, 108 Ann Taylor Factory stores, 539 LOFT stores, and 110 LOFT Outlet stores. All of its stores are in North America. In FY13, ANN opened 66 new stores, including seven new stores in Canada, bringing it total in Canada to 10 stores so ANN is making some initial headway in expanding beyond the US. In FY14, the plan is to open approximately 50 new stores in the US and Canada (40 of which will be LOFT stores) and close approximately 30 Ann Taylor stores, leading to net store growth of approximately 20 stores. In addition, ANN plans to optimize the size of an additional 11 stores.
Private Equity Firm Takes Large Stake
Later, we'll talk about some of the changes going on at ANN. And while they are an important part of the story, probably the most intriguing recent development is private equity firm Golden Gate Capital announcing in mid-March that it has taken a 9.5% stake in ANN. Golden Gate is now ANN's largest shareholder. This announcement led to a gap higher in the stock.
The reason why the Golden Gate Capital stake is such a valuable vote of confidence is because the firm is seen as having a lot of retail expertise. It has had a bit of a golden touch lately in retail, having helped revive companies like Eddie Bauer, J. Jill and Zale. The hope is that it can do the same for ANN.
According to a NY Times report, Golden Gate has a reputation for helping out distressed companies. An example is lending money to jewelry chain Zale in exchange for warrants convertible into 25% of Zale stock at a price of $2 a share. That investment has paid off nicely as Zale recently agreed to sell itself to Signet Jewelers for $21 a share. Another example is Eddie Bauer, which Golden Gate bought for $614 in cash and debt in 2009. They also almost sold Eddie Bauer to Jos A Bank for a nice profit before that deal was scuttled when JOSB agreed to merge with Mens Wearhouse (MW).
Unlike some of Golden Gate's other investments, ANN is not a distressed company. Rather the firm simply sees good value here as they have faith in ANN's management to refresh its brand. The firm supports the company's strategy to bolster new store growth and productivity at existing stores. Golden Gate has also offered to lend its expertise.
Plans for 2014
Product Assortment: ANN has described 2013 as a "challenging" year for all retailers. However, they performed quite well in spite of a difficult environment for retail generally. It turns out that 2013 was ANN's second consecutive year of record EPS and its fourth consecutive year of same store growth at both brands. At LOFT, the company has been growing all casual aspects of the brand and trying to balance the relaxed go-to-work separates with the casual element. As for Ann Taylor, the company has really been focusing on adding more and more fashion because that's what's selling in the Ann Taylor stores right now.
Online Sales: Nevertheless, management is taking steps in 2014 to improve performance even further. First, ANN is strategically realigning its organization to better position itself in an what it calls an omni-channel environment. What that means is that consumers are increasingly shopping online so ANN is investing in infrastructure and system enhancements in order to create a more integrated in-store/online offering. The realignment is expected to result in ongoing annual pre-tax operating savings of $25 million per year.
Phase I, which was rolled out in 2012-2013, has gone well. It has enabled ANN to fulfill online orders through its stores, enhancing its ability to meet customer needs and providing additional sales and margin opportunities. In 2014, ANN is laying the groundwork for Phase II of the program. This phase will give customers access to its online products from the store environment. Key site upgrades are planned in 2014 that will improve speed, simplify navigation and deliver a more user-friendly shopping experience. For example, ANN recently updated the appearance of loft.com website to better capture the brand's modern appeal and energy. The new aesthetic has generated a great response from clients. Also, an aesthetic refresh at anntaylor.com is nearing completion.
Expanding the LOFT Brand: Real estate is another huge part of ANN's strategy in 2014. ANN's primary focus will be on expanding the LOFT brand's footprint, which has enjoyed much higher sales growth than the Ann Taylor segment. Specifically, management really wants to build LOFT's presence in small and mid-tier cities where the brand is underrepresented but there is good potential there. And they want to build up the outlet channel. Of the new 50 new stores planned for 2014, about 40 of them will be LOFT stores (20 full-price stores and 20 outlet stores). So you can see the focus is really on the higher growth LOFT brand.
Another part of its real estate strategy is to modernize and refresh existing Ann Taylor stores which it continued to do in 2013. For the year, ANN met its internal objective of having 80% of its stores reflect the more modern format. These stores have delivered higher levels of productivity and profitability.
Expanding Beyond the US: International growth is another key growth area for ANN as virtually all of its stores are in the US. During 2013, ANN continued its successful expansion in Canada (going from 3 to 10 stores) where brand recognition for both Ann Taylor and LOFT is strong. ANN plans to open a handful of additional stores in Canada in 2014. At the same time, ANN is moving forward with plans to enter Mexico with the LOFT brand in the back half of the year.
Lou & Grey Has Potential: Finally, ANN is developing a new brand concept under the Lou & Grey name. The focus of Lou & Grey is to combine style and comfort so it's very much in sync with how women are dressing today. ANN is assessing a range of opportunities to grow this brand, including a shop-in-shop concept and the testing of free-standing stores. ANN described Lou & Grey has a key growth initiative within the LOFT segment.
Financials
A few years ago, ANN seemed to be in perpetual turnaround mode. They would tend to miss as often as they beat. However, they seem to be doing much better these days. They have beaten EPS expectations for 11 quarters in a row although revenue seems to come up a bit light about half the time. We think a big reason for the improved performance is that management is wisely focusing more on its more lucrative LOFT brand which caters to a younger woman. LOFT now makes up about 2/3 of ANN's stores and about 61% of FY14 revenue. This dynamic is very evident in ANN's new store plans: of the 50 new stores to open in 2014, about 40 will be LOFT stores. At the same time, ANN will close about 30 Ann Taylor stores.
In terms of its most recent earnings report, on March 14, ANN reported Q4 (Jan) results. EPS doubled to $0.10, which was $0.03 better than consensus. Revenue rose 2.6% YoY $623.3 million, which was basically inline with its prior guidance. Same store sales in Q4 came in at +2.9%, clearly fueled by strength at the LOFT brand (Ann Taylor -1.1%, LOFT +5.7%). However, ANN guided Q1 and FY15 revenue a bit below consensus due to extreme weather concerns early in Q1 and a still highly promotional retail environment. However, relative to other retailers, the guidance was not that bad.
For all of FY14, gross margin declined to 53.9% from 54.8% in FY13. Gross margin was hurt by a highly-competitive retail environment, which caused ANN to be more promotional at both brands in order to clear through inventory. Margins were also impacted by higher levels of client shipping associated with a full year of omni-channel sales. A couple of positive points is that ANN has guided to basically flat gross margin this year so the margin degradation should stop. Also, Q4 gross margin was actually up slightly at 49.3% vs 49.1% in the year ago period. It was the only quarter in FY14 to see improvement so that was a good way to close out the year.
Ann Taylor had a strong product offering and higher conversion in Q4, but traffic was soft in store, especially in those markets where weather was a factor. In terms of the product, Ann Taylor generated a strong response across the assortment with the fashion offering resonating especially well, particularly product that was special or holiday-inspired. Also, its weddings collection and its expanded events line of special occasion dresses performed particularly well, including little black dresses and party skirts. In addition, handbags, jewelry and shoes continue to be standouts. Turning to LOFT, the brand continued its strong momentum in Q4 with clients responding very positively to the brand's offering of versatile and affordable fashion. LOFT successfully navigated a challenging environment, executing on its strategy to reduce the level of promotional activity and deliver performance metrics that were all up versus a year ago.
Overall, ANN has performed quite well over the past couple of years, making it one of the few retailers to have weathered the protracted weakness in US consumer spending (many others have done poorly). Soft traffic and tepid consumer spending across the industry impacted ANN in Q4, particularly at its Factory Outlet centers and cold weather areas. Looking ahead, management noted on the Q4 call that its spring fashion offering continues to resonate in some of the warmer climate regions. The hope is that there is some potential for pent-up demand when temperatures in the north become favorable. The balance sheet at year-end remained strong with more than $200 million in cash, or about $4.40 per share, with no debt.
Valuation
In terms of valuation, ANN scores above average on each of the four key valuation metric rankings. The real standout is EV/Sales, which at 0.7x, ranks ANN in the 84th percentile. However, keep in mind that retailers tend to attractive EV/Sales ratios so this is not quite as positive as it normally might be for a non-retailer. In terms of other rankings, ANN generates a solid Free Cash Flow (FCF) yield, which at 4%, ranks ANN in the 73rd percentile. Its EV/EBITDA ratio of 6.2x places it in the 69th percentile which is good as well.
Shareholder Yield (dividends + buybacks) is a ranking that readers of past Value Leader reports know that we really like to see a high number on as it shows management thinks its stock is cheap and that they are being aggressive in terms of returning cash to shareholders. ANN ranks in the 62nd percentile for Shareholders Yield, which is above average but below the rankings we normally see when we choose stocks to profile. The reason they have a mediocre ranking is they do not pay a dividend. Offsetting that somewhat is the fact that ANN has been good about share buybacks. In 2013, ANN repurchased 1.5 million shares which lowered its average diluted shares outstanding for the year by more than 4% to 46 million.
In terms of P/E's, ANN does not guide for EPS, but analysts expect the company to earn $2.41 this year (FY15) and $2.78 next year (FY16). That works out to a current (FY15) and forward (FY16) P/E's of 17.0x and 14.7x, respectively, which are quite attractive in light of ANN's recent financial performance. We can see why Golden Gate Capital sees some value here.
Conclusion
ANN should be an attractive name for value investors. Despite a reduction in foot traffic and sluggish consumer spending, ANN's core retail brands have held up quite well relative to other retailers over the past year or so. That's a statement that probably would not have been made by us a few years ago when ANN seemed to be a perennial turnaround story. They seem to have gotten the fashion right and they are smartly focusing more of their time and resources on their LOFT brand which has consistently outperformed the Ann Taylor brand. There is also the potential for pent-up demand once this horrible winter finally moves on. Also, keep an eye on ANN's Lou & Grey brand. It may be small now but it has the potential to blossom into a very nice business for them.
A recent development only cemented our view that ANN has an attractive risk/reward at current levels: Private equity firm Golden Gate Capital announced in mid-March that it has taken a 9.5% stake in ANN and is now ANN's largest shareholder. Golden Gate is not just any private equity firm. It's viewed by the market as having a good deal of expertise in the retail sector, so them taking a large stake is particularly positive. They have made smart investments in Eddie Bauer, J. Jill, Payless Shoes and Zale (which recently agreed to sell itself to Signet Jewelers).
There are risks. ANN concedes that the consumer environment is still highly promotional and foot traffic has been weak. Keep in mind that they just guided Q1 (Apr) and FY15 below consensus. Other warnings may follow this year. Also, the tough consumer environment caused margins to compress in 2013 and they are not expected to improve in 2014. Another problem is that revenue was basically flat in FY14, which is not great, and its operating margin is in the mid-single digits. Also, we are not thrilled that they do not pay a dividend. It's not a deal breaker but a dividend is important for value investors. On the positive side, they do have about $4.40 per share in cash with no debt. So the balance sheet does appeal to value investors.
Overall, we like the risk/reward with ANN at current levels. P/E's in the mid-teens seem pretty reasonable in light of the positives going on at ANN, especially the strength of the LOFT brand which is the focus of the new store openings in 2014. Also, the Golden Gate stake was a nice cherry on top. We are not saying the stake means the firm may try to acquire the whole company (although they have done that with other retailers). Rather it provides investors with a sense of confidence that a firm like that is seeing the same things. We also like that the stock has pulled back the past couple of days.
--Robert Reid, Briefing.com
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