Ascena Retail: I Just Don't See A Way Forward

About: Ascena Retail Group, Inc. (ASNA)
by: Pinxter Analytics

Ascena Retail has worked hard to reduce costs and increase efficiency as it battles against the shift to online retailing.

As it streamlines efficiencies, improved IT capabilities, store-specific promotional activities and closes around 200 stores annually, it plans to cut over $300 million of costs.

However, the market dynamics of traditional brick and mortar are not in its favor as it seems to have exhausted most cost-cutting options and is focusing on store closures.

Even as EPS is expected to remain stable from expense control, excessive store closures and lack of a meaningful eCommerce platform has sales projections continuing to show a decline.

With such circumstances, I remain neutral to slightly bearish on the company and believe it can be slightly overvalued based off 2019 and 2020 EPS growth expectation when compared to industry peers.

Ascena Retail (ASNA) is a brick and mortar retail company that sells clothes and accessories through multiple brand segments across the United States.

It's no secret that we're not shopping for most of our clothes and 'stuff' in actual stores anymore. Once we know our sizes we are more likely to purchase them online through Amazon (AMZN) or a specific company's website.

This has caused severe headwinds for retailers who have a high nationwide presence as brick and mortar store operators. Whilst companies like Amazon don't have much upfront costs (relative to retailers), they've included free shipping for Amazon Prime members and the concept of the one-stop-shop has enticed consumers to spend there instead of looking around multiple stores.

There is, however, still a silver lining for retail. Even though companies like MySize (MYSZ) are working to use basic mobile technologies to find the perfect fit for its retailers and customers, there remains the issue of measurements and sizing which is currently unsolved for a large portion of the population and they'll frequent their nearest establishment to measure and purchase apparel. Apparel returns at the classic brick and mortar stores settles around 9% around the United States, whereas online shopping return rates are 30%.

There remains another segment of the population which continues to purchase apparel and accessories in actual stores as well, mostly the slightly older generations which either don't like the technology or simply enjoy getting out and finding what they like instead of doing so in front of a screen. There are also some portions of the younger population who still enjoy shopping at actual stores as a social experience, which will continue to aid some retention of the former glorious brick and mortar retail business.

Some of Ascena's brands have the potential to capitalize on these factors.

The Brands

The company sells through 4 business segments and operates over 7 unique brands around the United States. The company's Premium segments operates Ann Taylor and LOFT, its Value segment operates Maurice and Dressbarn, its Plus segments operate Lane Bryant and Catherines and its Kids segment operates itself through various brands. The company bought ANN Inc. for $2 billion back in 2015, mostly in cash.

As of their latest report, the company's Premium segment grew comparable sales by 8% and its Kids segment by 12% but was offset by its Value and Plus segments, however, with a 3% and 2%, respectively.

Over the last 12 months, the company closed 198 stores across all segments including 26 stores in its Premium segment, 96 stores in its Value segment, 27 stores in its Plus segment and 49 Kids stores. They expect to close an additional 196 stores in 2019, in a sign of slimming down of underperforming locations.

Expense Control Measures Are Working

In 2018, the company reduced $137 million in overall expenses as it shut stores, laid off workers and worked to mainstream IT efficiencies and other store-specific cost controls. In 2019, the company expects these same measures to save them an additional $90 million and in 2020 another $34 million. The total savings expected from reducing operating expenses is around $300 million from 2017 to 2020 and an additional $24 million from sourcing savings.

Debt and Acquisitions

The company's debt-fueled acquisition of ANN Inc. back in 2015 was identified as a prime opportunity for the company and they have been able to reduce overall joint expenses by a significant margin since then. However, their joint $7.3 billion in sales (at the point of acquisition) was quickly reduced with headwinds to the entire sector and are now projecting 2019 sales to be 11% lower than that figure.

The company is expecting to pay ~$108 million in annual interest expense so, given the $150 million synergies from the acquisition and a modest bump in net income from the acquired brands, it seems that hindsight remains king and the company's overall standing was not improved by much as it added almost $1.5 billion in debt to its balance sheet. (Source: Guidance)

Financials and Expectation

The company is sitting on nearly $200 million in cash, as of its latest report, and is generating free cash flow of $180 million annually which should keep them well-positioned as they continue to cut costs and work on brand revamping.

The company expects 2019 sales of $6.5 billion on a gross margin (expected to slip from 2018) of 57.85%. They expect to close an additional 196 stores in 2019 and pay ~$108 million in interest expense. As for EPS, the company expects to report $0.05, given certain tax benefits and stock-based compensation deductibles but analysts project a loss of ($0.05) for the year.

For 2020, analysts expect the company to report a drop in sales to $6.46 billion but a rise in EPS to $0.08 as cost control measures continue to help them boost overall net income.

Valuation - Not Pretty

As the company expects to report a loss in 2019 (pending any modest expectations earnings beat from cost cutting synergies), 2020 is the year analysts expect the company to report EPS of $0.08.

Given revenues are expected to remain on the decline throughout that time period and the company has seemed to be exhausting its cost cutting measures to store closures, which then hurt sales, it's hard to justify a high price to earnings multiple based off 2020 expectations.

Peer comparison, from an EPS and revenue growth standpoint, can best be done against a slew of retailers who are in similar positions, underperforming Ascena and outperforming it. To justify the appropriate multiple of around 15x earnings, I review Urban Outfitters (URBN), American Eagle Outfitters (AEO), Abercrombie & Fitch (ANF) and Express Inc. (EXPR) from an EPS and revenue growth standpoint over the next 24 months and their 2019 earnings multiples.

EPS Growth REV Growth 2019 P/E
Ascena Retail 37.5% (0.8%) 36.4x (*)
Express Inc. (6.9%) (0.9%) 17.1x
Urban Outfitters 8.0% 3.7% 11.3x
American Eagle Outfitters 9.3% 5.7% 12.7x
Abercrombie & Fitch 2.7% 1.6% 17.7x

(*) Based off management projection of $0.05 EPS.

Anything over a 15x multiple to expected 2020 EPS, in my opinion, is not justified, unless the company projects a significant increase in comp sales or a future turnaround effort which will emphasize its eCommerce platform. This presents a fair value of around $1.20 per share, slightly lower than where the company is trading at right now. Even as they grow EPS at a higher rate than their peers, there's a long-term risk of lack of revenue growth which must be baked into the valuation equation.

Non-Investment Conclusion

Given the company's financial position, I don't think that it's going to be insolvent or declare bankruptcy in the near or even longer-term future, but the fact that its cost cutting strategy has narrowed down to store closures, which are expected to hurt sales in the long run, brings me to believe the company will not be able to grow revenues in a meaningful way in its current form.

The company needs a more aggressive eCommerce platform and more partnerships with online giants to boost its offerings and sales avenues before I would consider a bullish stance on Ascena. The reality of the brick and mortar retail headwinds is a profound one, but multiple companies have found ways around the harshest of those headwinds and some of the company's brands have the potential to do so, given their recent comparable store sales growth and high holiday sales demand.

I remain neutral on the company's performance and slightly bearish on their price action throughout the year.

Disclosure: I am/we are long AMZN, MYSZ, ANF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Opinion, not investment advice.