Be Careful Betting On The Action At Ann

| About: Ann, Inc. (ANN)


Women's retailer Ann has struggled to produce profit growth to-date in FY2014, hurt by declines in its gross margin.

The company's performance has led to activist shareholder calls for it to put itself up for sale.

Given a forecast of negative profit growth for the current fiscal year, investors should probably stay away from the story.

Women's retailer Ann (NYSE: ANN), operator of the Ann Taylor and Loft brands, has been struggling to find profit growth in FY2014, a trend that seemed to weigh on its stock price for much of the current year. The company has been hurt by higher promotional activity and difficulty in attracting increasing volumes of customer traffic, which has also been negatively impacting results at competitors, like Chico's (NYSE: CHS).

However, Ann's stock price found stronger momentum over the past month, thanks in part to activist shareholder calls for the company to engage in efforts to sell itself, a course of action that Ann is rumored to be considering. So, deal or no deal, is Ann a good bet for investors?

What's the value?

Ann is a major player in the women's retail space, operating a network of more than 1,000 locations around the country. The company has been wise to diversify beyond its trademark upscale Ann Taylor brand with its casual, moderately-priced Loft brand, which has allowed it to capture sales from a growing group of more price-conscious customers. The net result for Ann has been a rising trajectory for its total sales, up 36.4% over the past four fiscal years.

In its latest fiscal year, it was a continuation of the growth story for Ann, highlighted by a 5.0% increase in revenues that was a function of a moderate expansion of its store base and its fourth straight year of higher comparable store sales, up 2.3%. On the downside, though, the company was hurt by a 90 basis point contraction in its gross margin, due to lower average prices at both of its business segments, led by a 6.6% drop at its Ann Taylor unit. The lower gross margin caused Ann's adjusted operating profitability to shrink as well, despite the cost savings benefit from recent restructuring activities, limiting the company's operating income growth to a gain of 2.0%.

Looking into the crystal ball

Of course, the question for investors is whether Ann can continue to deliver profit growth going forward, thereby providing a solid foundation for a higher market valuation. On that score, things aren't looking so hot, given the company's 13.3% decline in adjusted operating income to-date in FY2014. As was the case in the prior year, Ann has been hurt by a need to increasingly engage in promotional activity in order to generate customer transactions, which led to a roughly 240 basis point drop in its gross margin during the period.

Naturally, Ann isn't alone in its current profit growth challenges, as Chico's has been dealing with many of the same issues. While the company's comparable store sales growth has been slightly better than Ann's, up 0.3% in its latest fiscal quarter, the sales seem to have been generated with a healthy dose of promotions and discounts, evidenced by a 200 basis point decline in its gross margin in FY2014. Combined with higher overhead costs required to support a growing store base, including forays into Mexico and Canada, it has added up to lower adjusted operating profitability for Chico's, with its operating income declining 27.1% during the period.

A better way to go

Given the current profit growth trajectory at Ann, as well as management's forecast of continued gross margin pressure for the remainder of the current fiscal year, investors should probably focus on sector players that have continued to deliver profit growth in the current environment, like G-III Apparel Group (NASDAQ: GIII). As one of the largest licensees of the Calvin Klein brand, G-III Apparel Group has been a big beneficiary of the rising popularity of the brand, a major factor behind the company's ability to post a 114.5% increase in revenues over the past four fiscal years.

The company has also reinvested the associated rising profit and cash flows wisely, adding retail brands to its largely wholesale-oriented operations, a strategy that has allowed it to post a higher gross margin over time, including a 180 basis point improvement in its latest fiscal year. More importantly, G-III Apparel Group's retail operation will likely be the company's growth engine for the future, as it builds on its relatively small base of roughly 400 stores, helping it to potentially continue delivering positive profit growth and greater shareholder value in the future.

The bottom line

With a forward P/E multiple of approximately 21, as illustrated in the below table, Ann seems a bit pricey, in light of the fact that management expects adjusted earnings per share to decline by almost 9% in the current fiscal year.

FY2015 Estimated Net Income $2.6 B
# Shares Outstanding 46.9 M
Diluted EPS $2.00
P/E Multiple 21.0

Source: Ann 2Q2014 Press Release

While a buyout is certainly possible, given the presence of activist investors on the company's shareholder roll, it is probably not a good bet for investors, given the uncertainty of a transaction and the downside price risk in the event that the company decides to go it alone. As such, investors should probably take a pass on the action at Ann.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.