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"That dress that I was wearing last night at the Yelp holiday party? The one that everyone and their brother/mother/sister complimented me on? It came from Dress Barn." -- Amy H., from Yelp.com

"Dress Barn is not nearly as frumpy as it used to be." -- Nadine G., from Yelp.com

"I was taking a walk during my lunch hour and the styles they had in the window caught my eye. Wait ... are those non-soccer mom jeans paired with a stylish, sexy shirt? Hook, line, sinker." -- Lori L., from Yelp.com

Ascena Retail Group's (NASDAQ:ASNA) flagship, Dress Barn, has a reputation that needs no introduction. Why anyone would choose to use the word "barn" in a clothing line catering to women is mystifying to me. But what's done is done. From the above quotes, I could draw the conclusion that Ascena is turning Dress Barn's image around. Unfortunately, investment decisions are not so simple. First, Ascena has two other clothing outlets, and Dress Barn's apparent improvement in public opinion may not extend through the rest of the company. Second, our perceptions of said improvement can be biased in a thousand different ways. The numbers need to tell us that this company is worth purchasing.

The Company

Ascena Retail Group is a specialty retailer of apparel for women -- from tweens through middle age -- via three different wholly owned subsidiaries: Dress Barn, Maurices, and Justice. Dress Barn caters to women aged 35-55 with "career and casual fashion" choices that, according to Ascena's 2011 investor presentation, are as fashionable as Macy's (NYSE:M) product line but less expensive. Maurices caters to women aged 17-34, and the company compares its product line to American Eagle (NYSE:AEO), with a price consistent with J.C. Penny (NYSE:JCP) and Stage Stores. Justice caters to tweens and young teens and focuses on clothing more fashionable than lines carried at Target (NYSE:TGT), but only somewhat more expensive.

Free Cash Flow Calculation

A discounted free cash flow analysis can show us whether there is hidden value in the company. Instead of the company's WACC, I use 10% (my required return) to discount future returns. Analysts estimate 15% growth for the next five years. As analysts tend to be overly optimistic, I cut the growth estimate by 10% and used 13.5% for six years, and then a 3% growth rate into perpetuity. Here are my numbers, open to critique:

Actual

Income Statement ($ thousands)

2011

Net Sales

$2,914,000.00

Cost Of Goods Sold

$1,682,300.00

Selling, general & administrative

$852,100.00

Depreciation

$0.00

Operating profit

$379,600.00

Balance sheet ($ thousands)

Cash and Short Term investments

$297,600.00

Inventory

$365,300.00

Accounts receivable

$25,300.00

Total operating current assets

$688,200.00

Net PP&E

$489,000.00

Total operating assets

$1,177,200.00

Accounts payable

$349,900.00

Accrued expenses

$0.00

Total operating current liabilities

$349,900.00

Free Cash Flow Calculations ($ thousands)

Operating Income

$379,600.00

Tax on Operating Income

$136,656.00

NOPAT

$242,944.00

Net Operating WC

$338,300.00

Net Operating Long Term Assets

$489,000.00

Total Net Operating Assets

$827,300.00

Investment in net operating assets

$97,200.00

Free Cash Flow

$145,744.00

Free Cash Flow

$145,744.00

Growth Rate in free cash flow

WACC / or required rate of return

10.00%

Horizon value

$4,584,637.88

Value of operations

$3,565,087.82

Value of investments

$138,500.00

Total value of firm

$3,703,587.82

value of all preferred stock

Value of equity

$3,703,587.82

Number of shares (millions)

152,150.00

Estimated Share Price

$24.34

Ascena ends with a DCF value of $24.34. As of May 17, 2012, the stock was selling at a little over a 20% discount. I prefer to purchase my stocks at a 25% premium, so I will most likely look to sell puts on the stock. Fortunately, Ascena has both $18 and $18.50 strike prices for the June 2012 option chain.

Before I commit to a position, I'd like to see what kind of growth Ascena requires to justify its current price in the mid-$19s. It turns out that current prices assume an 8.5% growth rate in my model. So if your due diligence on market circumstances leads you to believe that Ascena cannot grow at 8.5% or better, then you should avoid investing in the company.

Ratio Analysis

To get some idea of whether our guesstimated growth rate has any basis in reality, let's look at Ascena's metrics in relation to its competition. Roughly, I'm looking at growth, efficiency, financial health, and overall valuation. Ideally, I could compare it to the overall industry, which should represent all of Ascena's potential competitors. But since I don't know how Finviz defines "industry," and many clothing stores are not directly competitive, I chose three of Ascena's direct competitors as proxies.

Ratio

ASNA

"Industry"

Macy's

American Eagle

JC Penny

Return on Investment (5 yr avg)

12.41

16.24

-1.57

15.08

4.39

Return on Equity (5 yr avg)

15.52

18.32

-4.24

16.58

9

Inventory Turnover

6.09

5.25

2.99

5.98

3.28

Net Income/employee

$21,244.00

$3,465,589.00

$7,637.00

$23,339.00

-$2,384.00

Net profit margin (5 yr avg)

5.62

6.92

-1.14

7.81

2.36

Current ratio

2.36

2.36

1.48

3.18

1.92

debt/equity ratio

0

16.52

115.32

0

72.94

Sales - 5 yr growth rate

17.51

11.1

-0.42

2.49

-2.81

Earnings per share - 5 yr growth rate

12.9

7.5

10.1

-14.55

N/A

P/E ratio (NYSE:TTM)

16.23

23.18

12.24

24.87

N/A

Price to tangible Book

3.57

4.06

9.17

2.76

1.48

Price to Free Cash Flow

16.23

23.18

13.04

70.35

N/A

Several things jump out at me when comparing Ascena to industry numbers. Ascena seems to hold up poorly when we examine efficiency. Both Ascena's ROI and ROE are lower than the industry average, although its lack of debt may account for this. But most the most glaring difference is Ascena's net income per employee when compared to the industry average ($21,244 vs. $3,466,000). However, I have to say the industry average seems suspect, especially when I compare it to Ascena's competitors. Finally, Ascena's net profit margin is lower than the industry average, and indicates a weakness we should expect management to address in future conference calls.

On the bright side, Ascena's sales and earnings growth rates exceeded the industry average, the company's financial health seems to be in order (with room to grow through debt if needed), and it appears valued at a lower-than-industry average (when examining P/E and free cash flow ratios). Price per tangible book value is somewhat higher than industry average, perhaps because the company's stores tend either to be rented mall space or owned strip mall real estate.

Since industry numbers are vague and, at least in one case, suspect, I will look at three main competitors. Of the three, American Eagle seems to be the strongest and J.C. Penny looks shockingly weak (I may have to examine JCP for diagonal put spread opportunities). Again, Ascenca lags in areas of profitability and efficiency, with American Eagle boasting higher ROE and ROIs (without any debt as well), a slightly faster inventory turnover, and a business that generate $1,100 dollars more per employee. Not surprisingly, five-year average profit margins are higher as well. However, investors pay for this increased efficiency by paying nearly 50% more for earnings (P/E of 24.87 vs. 16.23) and 433% more for free cash (70.35 vs. 16.23). After reviewing the ratios, I am confident that Ascena is competitive within its industry, and appears inexpensive.

Ascena is not the perfect stock, however. In fact, it has some glaring flaws, such as brand reputation and efficiency. Furthermore, the lack of a dividend makes this unsuitable for Seeking Alpha's large dividend growth strategists. However, I feel that the discount in price justifies investment consideration for those who do not rely on or prefer dividends. Furthermore, healthy growth rates and a lack of debt (as well as the ability to meet current obligations) limit the downside risk. For those looking for value per dollar of free cash flow, and are willing to buy as the market pulls prices down, this stock may fit the bill.

Source: Ascena's Dress Barn Is A Potential Cash Cow