Ain’t No Cure for the Specialty Retailing Blues
Louis Meyer
Tuesday, November 18, 2014 1:19:48 PM
On 11/6/14, ANN INC. (NYSE-ANN) updated its outlook for 3Q and the full fiscal year; in addition, the company provided its outlook for 4Q. The press release noted the company had negative same store comps due to a variety of factors including lower mall traffic and a promotional retail environment, both of which appear to be ongoing industry trends. ANN also noted that it had higher transportation costs from using air freight in the latter part of the quarter. The company also announced it has commenced a “comprehensive, end-to-end assessment of its supply chain.” ANN first appeared on the potential takeover radar screen in late August 2014 when two shareholder activists (owning more than 1% S/O) sent a letter urging it to explore strategic alternatives; the company guided 2Q guidance downward earlier that month. Last, in March 2014, Golden Gate Private Equity Inc. (“Golden Gate”) filed a 13-F disclosing a 4.375M share position (9.5% S/O) in the company.
Given the updated financial guidance, we believe any near-term takeover price would be in the $40-$44/share range, well below our low-$50s midpoint based on the estimated deal price ranges in our initial blog. ANN noted that it expects to “maintain its healthy balance sheet” for the remainder of the fiscal year; we decode that that as shareholders should not expect any other corporate action, such as a special cash dividend or a large one-time share buyback, until mid-1Q15 at the earliest. While the recent decline in gasoline prices may be a catalyst for increasing discretionary consumer spending, we feel the timing of the drop is probably too late in the year to have a material impact on 4Q sales estimates. We note the ANN holiday sales totals are similar to the other three reporting quarters (unlike many specialty retailers); the company may actually be at a disadvantage this shopping season as any increase consumer spending may be applied to more discretionary purchases rather than personal business and casual clothing.
The primary catalyst for maximizing the ANN value is a leveraged buyout, most likely by a PE firm; we believe Golden Gate remains the primary buyer given their large share ownership (and ~$36/share average price). We feel an updated blended probability analysis would be fruitless at this juncture as ANN appears to be moving in the direction of an operational turnaround. While the Ann Taylor and Loft brands continue to have good name recognition, operating expenses seem to have gotten bloated over the years (and ANN is not a plus size retailer). Slimming down excessive and/or productive expenditures is a start; ANN closed its Madison Avenue store location and is looking to pare working capital use by more closely managing inventory. Both actions should have probably been taken a while ago (along with relocating corporate employees out of their spacious Manhattan headquarters).
The ANN trading multiples are inline with Chico’s FAS, Inc. (NYSE-CHS), the company we view as the best comparable. The ANN and CHS FY16E valuation multiples based on $38.00 and $15.50 share prices are 17.8x and 18.5x P/E and 6.9x and 6.6x EV/EBITDA, respectively; the mid-cap companies have similar EBITDA margins (10%-12% range). In comparison, large-cap L Brands, Inc. (NYSE-LB) has about 10x the market capitalization as ANN and double the EBITDA margin; at $77.50/share, LB trades at FY16E valuation multiples of 20.7x P/E and 10.7x EV/EBITDA. A 20.7x multiple of ANN FY16E $2.13 EPS implies $44/share (the top end of our updated takeover value). The valuation multiples of Express, Inc. (NYSE-EXPR), a mid-cap specialty retailer, represents trading multiples the other end of our valuation spectrum. At $14.75/share, EXPR’s FY16E multiples are 13.3x P/E and 4.7x EV/EBITDA (11% margin) which imply an ANN share value in the mid-high $20s and reflect the potential downside share price absent the current catalysts.
With $306M debt, $156M net debt and FY15E $240M EBITDA, ANN has the debt capacity (at 2x Debt/EBITDA) to repurchase ~12% of S/O if the stock drops into the low-$30s. While a lower buyback price is more beneficial to ANN compared to $40-$42/share (i.e. the price range after shareholder activists’ letters were disclosed in August), we believe repurchases below $35/share are highly unlikely given the $35-$42/share trading range since March 2014. The updated current fiscal year guidance effectively took away $50M of potential EBITDA - this is real money for ANN and company management would be smart to find ways to regenerate that amount sooner than later. We believe the shipping issues on the West Coast are temporary and will eventually be resolved; poor inventory management, oversized stores and poor locations (relative to declining retail store traffic trends) are ongoing issues that the company controls. Overall, we view Golden Gate as an entity that will catch the company’s stock price if it is falling but would not expect to pay full value if the asset has minimal operational upside from being better managed.
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