Street Watchdog Starts Ascena Retail at Buy on New Omni-channel Platform
   
Price Target $12.60

  
January 24, 2017

The retail sector has been one of Wall Street’s favorite whipping boys this past month as holiday sales came in a bit softer than expected at many major department stores.  Earlier this month, both Macy’s and Kohl’s reported disappointing holiday sales highlighting the uphill task facing brick and mortar retailers to win back shoppers from the likes of Amazon and other online retailers.  Ascena Retail Group, Inc., whose brands include Ann Taylor and Lane Bryant, similarly warned that disappointing holiday traffic led to increased promotional activity and that the current quarter’s losses would be wider than expected.  Naturally this led to a slew of downgrades.  We, however, have reason to be cautiously optimistic with regard to Ascena Retail given the company's plans and consequently are placing a price target of $12.60 on the stock based upon 2018 forward earnings.


Who is Ascena Retail?

Ascena Retail Group, Inc. is a leading national specialty retailer operating ecommerce websites and over 4,900 brick and mortar stores throughout the United States, Canada, and Puerto Rico.  Its retail websites include ascenaretail.com, AnnTaylor.com, LOFT.com, louandgrey.com, maurices.com, dressbarn.com, lanebryant.com, cacique.com, Catherines.com, and shopjustice.com.  During the company’s fiscal fourth quarter of 2015 (May 2015), Ascena announced its plans to buy Ann, Inc. for about $2.16 billion, consolidating the respective companies’ brands in an effort to attract more working women.  The company’s stores can be organized into four distinct segments: premium fashion, value fashion, plus fashion, and kids’ fashion.  The diagram below from the company’s Analyst Day presentation last week shows the history of the brands.
  
Premium Fashion:  Ascena’s premium fashion segment consists of the Ann Taylor, LOFT, and Lou and Grey.  ANN has over 1,000 specialty retail and outlet stores, ecommerce operations, and various licensed franchises in international territories, which allow customers to shop in over 100 countries around the world.  These segments offer classic suits, separates, dresses, shoes, and accessories under the Ann Taylor, LOFT, Lou & Grey, Ann Taylor Factory, and LOFT Outlet divisions.

Value Fashion:  Ascena’s value segment includes Maurices and Dress Barn.  The company has nearly 1,000 Maurices specialty retail and outlet stores in addition to its ecommerce operations.  These stores are concentrated in smaller markets of up to 150,000 people, and they cater to small town preferences.  Maurices’ product line encompasses women's casual clothing, career wear, dressy apparel, active wear, and accessories.  Dressbarn consists of over 800 specialty retail and outlet stores as well as ecommerce operations.  Its aim is to maintain a distinctive position in the marketplace by providing its own private labels and contemporary fashions.  These stores are located primarily in strip shopping centers in higher density markets and surrounding suburban areas.

Plus Fashion:  Ascena’s plus segment consists of Lane Bryant and Catherines stores.  Lane Bryant has over 800 retail and outlet stores as well as ecommerce operations.  The segment offers brand name clothing in plus-sizes 14-28 and is located primarily in small towns and suburban areas.  Catherines, with over 400 locations nationwide, offers plus sizes 16-34 and extended sizes 0X-5X.  Its locations are similarly concentrated in small towns and suburban areas.

Kids Fashion:  Ascena’s kids segment, Justice, has over 900 specialty retail and outlet stores, e-commerce operations and various licensed franchises throughout the United States, Puerto Rico, Canada, Russia, and the Middle East.  This brand is the largest premier “tween” specialty retailer in the world, offering apparel to girls in the 7-14 age range.  Justice designs and creates its own Justice-brand products in-house.  It offers clothing, accessories, footwear, lifestyle products, and electronics.  Justice retail stores are located primarily in malls, outlet centers, and strip shopping centers.


  
The Good, The Bad, & The Ugly
 
Let’s Begin With The Ugly:  When it comes to Ascena Retail, while there is much that is good, there’s some that is bad and some that’s downright ugly.  Let’s begin with the latter.  Ascena’s  2016 holiday sales were ugly for sure.
As  the  table  shows,  companywide 2016 holiday sales (from Nov 19 to Jan 02) declined 3.1% YOY.    Of the company’s four major segments, only one (kids fashion) experienced sales growth this holiday season versus the prior, with a 2.7% overall increase.  According to a press release on January 10th, the company now expects to post a non-GAAP loss of $(0.11) to $(0.08) for its fiscal  2017  second  quarter  ending the 28th of January.  The release goes on to say that, “Based on ongoing traffic headwinds, the Company now expects full fiscal 2017 non-GAAP EPS in the range of $0.37 to $0.42 for the 52-week period
ending July 29, 2017.”  In a 6-week period from December 9th to Friday’s close, the stock has tumbled nearly 40% falling from $8.04 to $4.88 within that time span, and it is nearly 57% off its 52-week high of $11.26 last March.


Now the Bad:  In a fairly healthy economy with low unemployment, one would expect traditional retailers to be reporting expanding sales and higher profits; yet many are reporting slowing growth and lower margins due to the need for constant promotional activity.  A recent poll shows that a third of consumers would rather wash dishes than hit a traditional retail store.  Yet while some retailers are going bankrupt or closing stores, Amazon continues to post record sales and profits.  Why is Amazon dominating the retail marketplace?  More importantly, how can Ascena Retail compete more effectively with Amazon and other online retailers in the face of macro shifts in the way today’s consumer shops?  We will answer these questions and more in more detail below.
 
Where’s the Good in All of This?:  It is not all doom and gloom for the traditional brick and mortar retailer.  While some are struggling, TJX Companies, owner of T.J. Maxx, Marshalls, and HomeGoods, plans to boldly grow its number of stores by over 50%.  Sporting strong sales growth last year, CEO Ernie Herrman said the company will have 5,600 stores when it’s finished expanding, up from a current total of about 3,700.  In 2015, the company opened over 200 new stores, and last year it added some 200 more, representing a 5% growth.  The company is considering even more store openings beyond the 5,600 target as it contemplates the potential to expand into additional countries or open new chains in existing markets by snapping up bargains for buildings that other retailers have closed. 
 
At the end of Ascena’s most current quarter ended October 29, 2016 (2017-Q1), the company had a total of 4,920 total store locations.  During the quarter, the company opened 29 new stores and closed 15.  Clearly, retailers that are adaptable will be able to successfully compete with the likes of Amazon.  Rather than throw the baby out with the bathwater as other analysts have done with the retail sector, we’re looking at a company who has recognized its weaknesses and is adopting the steps needed to face this brave new world of retail.
 
 
Ensuring Ascena’s Continued Success
 
Margin Enhancement:  At last Wednesday’s Investor Day conference, companywide CEO David Jaffe hit the nail on the head by highlighting how the company is positioning itself to “navigate dramatic industry change.”  A major challenge facing Ascena and other retailers is a sustained spending shift away from consumer discretionary. A sustained spending shift away from consumer discretionary is a macro force that no individual retailer can rapidly change; however, far from shrinking into oblivion as other retailers have done, Ascena is putting in place long-term plans to respond decisively to structural challenges to its business model.  The company is devoting itself to procurement and supply chain excellence in addition to advanced analytics to drive margin enhancement.  The company is forecasting $235 million in cost savings in FY2017 and FY2018 from deal synergies relating to supply chain capabilities and non-merchant procurement as well as cost savings from product costs and SG&A optimization.  Similarly, cost savings are expected from enterprise transformation and more internal product sourcing.  While all of this is promising for the bottom line, we are especially excited about the Omni-channel platform rollout, which we’ll discuss below.
 
Selling to Today’s Omni-channel Consumer:  With the increasing market fragmentation caused by Amazon
and other online retailers, traditional retailers will need to devise ways to compete more successfully to show top line growth.  Ascena’s new Omni-channel platform presents a definite shadow demand opportunity. The diagram to the right shows Ascena’s rollout schedule for its Omni-channel platform.  Online ordering in any particular store is currently available across all brands.  By the end of 2017, the company will have in place an internal ATG website, ship-from-store capability, and responsive mobile capabilities (a must for millennials).  This will serve to help reduce the omni-channel gap between Amazon and Ascena.             
  

Looking Forward

While Ascena Retail is facing many of the same challenges that traditional brick and mortar retailers now face, this is a responsive and dynamic company that is putting in place initiatives to effectively manage those challenges.  The company has a strong balance sheet with over $270 million in cash and cash equivalents, and it had over $445 million in cash flow from operations last fiscal year. 

While the market was generally disappointed with the 2017-Q1 numbers that we saw in December, keep in mind that revenues actually grew by 0.4% QOQ from $1,672.0 million to $1,678.4 million.  Amazingly, cost of goods sold fell from $776 million in 2016-Q1 to $664 million in 2017-Q1!

At Friday’s closing price of $4.88, the market is valuing this retail powerhouse at a paltry $950 million.  Some have hazarded a guess that the price is so low, an activist investor may want to “kick the tires” on this holder of several relevant apparel concepts.

While we don’t foresee blowout earnings per share from continuing operations of $0.99 as in FY2013, by assessing the company’s financials from 2013 to 2016, as well as modeling pro forma numbers for the remainder of this fiscal year and the next, we are looking for a modest EPS figure of $0.38 for FY2017.  For FY2018 which begins at the end of July, we are a bit more optimistic and see positive revenue growth, expanded margins, and a higher EPS.  Consequently, we are forecasting FY2018 non-GAAP EPS of $0.70.  At a modest forward PE of 18, we impute a fair price of $12.60 for Ascena Retail based upon our estimates for 2018.  As such, we believe the company is significantly undervalued at the current trading range.