Description

Ascena Retail Group is a holding company with five North American female apparel retail brands: Justice (998 stores; 29% of revenues; 41% of EBIT), Lane Bryant (770 stores; 23% revenues; -2% EBIT), maurices (907 stores; 20% revenues; 35% EBIT), dressbarn (831 stores; 21% revenues; 16% EBIT), Catherines (390 stores; 7% revenues; 10% EBIT). All offer reasonably priced merchandise appealing to a middle/upper-middle-class consumer. It was founded as dressbarn in 1962 and has grown by acquiring other retail brands since 2005 under the leadership of the founders' son. The most recent acquisition was of Charming Shoppes in June 2012. It is based in Mahwah, NJ.

ASNA’s portfolio of women’s apparel retail brands are being unfairly discounted due to (a) the recent weakness in Justice, its largest and highest profile brand; (b) lack of investor appreciation of likely incremental EBITDA resulting from major initiatives over the past two years; (c) high levels of capex spending in the recent past which has suppressed normally high free cash flow and hindered ASNA’s financial flexibility in the short run; (d) a weak retail environment overall, especially for apparel retailers.

Even with all the bad news and negativity, you only need to look out 18 months for FCF yield >10% unless trends in all of their brands get materially worse (and, by the way, their brands are not historically correlated). In effect, ASNA will get its own turnaround (in free cash flow, at least) regardless of the consumer from the reduction in capex. At ~4.0x EBITDA (both LTM and FY15) and no net debt (debt on the balance sheet is offset by cash that is mostly overseas in a Hong Kong subsidiary they use for sourcing from Asia), ASNA is a cheap stock suffering in a tough environment.

For perspective, ASNA is trading at the lowest valuation of any retailer with a market cap greater than $500m – even Abercrombie & Fitch, an undiversified teen retailer which just announced its 11^th consecutive quarter of negative same store sales. Other women’s apparel retailers or teen retailers with inconsistent performance are trading at higher valuations (Chico’s = 6.3x, American Eagle = 5.9x, Ann Taylor = 5.5x, Christopher & Banks = 5.4x, Express = 5.2x, Abercrombie = 4.4x)

Note: Financial information in the VIC table above refers to ASNA’s FY15 and FY16, ending July 2015 and July 2016.

Summary of ASNA’s brands

Justice: Based in New Albany, OH, Justice is the largest tween girl (core ages 7-12) specialty retailer in North America (its main competitors are Walmart and Target, but they are a distant #2 and 3). They focus on fashion clothing, merchandise, and accessories for tween girls. In November 2009, ASNA paid $160m in stock for the publicly traded Tween Brands (TWB) whose shareholders subsequently owned approximately 16% of ASNA. The implied EV/EBITDA multiple was 5.6x and 0.3x EV/Revenues for the ~900 stores at the time. Last month, the CEO of Justice announced his retirement after a long career.

maurices: Maurices was founded in 1931 in Duluth, MN. It is focused on small and medium-sized markets and runs its own credit card program. In many cases, it is one of a few places for women to get fashionable clothes in its markets. ASNA acquired Maurices in 2005 for $320m (10x LTM EBITDA or 0.9x LTM Revenues). As part of the acquisition, the company took on a $100m term loan which was repaid in full within 10 months. At the time, Maurices had nearly 500 stores. Maurices is currently run by George Goldfarb, who joined Maurices in 1985.

dressbarn: Founded by Roslyn Jaffe, the mother of the current CEO, in 1962 in Stamford CT. This is somewhat of a tired brand, but has a loyal following. Store counts have been stuck between 820 and 840 since 2008. Dressbarn is currently being run by Jeff Gerstel (since December 2011), who has been with the company since 2006.

Lane Bryant: Based in Columbus, OH, Lane Bryant was founded in 1900 as the first women’s apparel retailer devoted to plus sizes. A new turnaround specialist, Linda Heasley, has been running Lane Bryant for the past couple of years.

Catherines: Based in Bensalem, PA, Catherines is a 53-year old chain of women’s plus-size apparel retailer. It carries a broad range of clothing in extended sizes. It is ASNA’s smallest brand, but has had a successful turnaround since its arrival in the ASNA portfolio.

Lane Bryant and Catherines were acquired in June 2012 as part of ASNA’s acquisition of Charming Shoppes (CHRS). The purchase price was $927m (10.2x EBITDA; 0.4x Revenues).

CHRS had issued a convert in 2007 and used the proceeds to pay off an existing convert and to repurchase stock. That’s what put them in such a precarious situation in 2008 as customer traffic declined with the recession. After 2008, they were in turnaround mode, even being run by one of the partners from Alvarez & Marsal who had been involved in the Lehman bankruptcy.

Shared Services Group: While not a retailer, this represents the back-end services of distribution, transportation, sourcing, human resources, accounting, finance, and technology for ASNA’s retail brands. Since the acquisition of CHRS, ASNA has been executing a multi-year effort of consolidating their shared services with a long list of expensive projects:

• New retail distribution center in Etna OH.

• New ecommerce fulfillment center in Greencastle IN

• In-sourcing ecommerce capabilities

Their goal is to build scalable operations that can support more retail brands in the future and further leverage their infrastructure.

Management & Family: ASNA is run by David Jaffe, the son of the founder of Dressbarn. Collectively, the Jaffe family owns 20% of the company. Though David grew up in the business, he was away from it for many years as an investment banker and private equity investor prior to returning. He became CEO in 2002. There is an interesting dynamic tension in David: he eschews debt, but is an LBO guy at heart. So he tends to only act when there’s a really good deal on the table. Keep that in mind for later.

Why does this opportunity exist? The list is long:

• Justice trends are bad: This was the third quarter with negative Justice comps, and at -10%, it is getting worse (last Q213 was only +1%). While Justice only represents 29% of revenues, its higher historic profitability weighs higher on investors’ minds.

• Operational misstep at Lane Bryant: ASNA is in the process of turning around Lane Bryant, and progress had actually been faster than expected. They took a step back this past quarter with a -2% comp partially because they didn’t have enough inventory of certain sizes. The demand is there, but it was an execution mistake.

• Family ownership limits the ability for activists: Retail has been a space ripe for activist activity, but they know they will find limited success when 20% of the shares are owned by the Jaffe family.

• New capex = lower EPS: A new distribution center went live, which means that higher levels of depreciation are running through the P&L in advance of higher levels of revenues.

• The integration on the back-end of LB/Catherines has taken much longer than expected: The complexities of various back-end IT system has held back progress on many of the shared services initiatives.

• Delays at the port of Los Angeles/Long Beach has resulted in store inventory shortages in certain categories.

• Mall traffic has been weak and there is no hot fashion trend: Justice is most tied to malls, and according to many companies, there has not been any fashion “call to action” that is pulling people into stores.

• There is no near-term catalyst – admitted even by the CEO:

• FY15 (ends July) will be back-end weighted: They are still spending on integration, and they do not know when trends will improve, especially with consumer spending heading towards the iPhone 6 cycle. More recently, JCP, GPS, ANN, KSS, and ANF have all lowered expectations.

• No stock buyback any time soon: Jaffe sees more long-term value in buying a distressed retailer at a good price to plug into their shared services infrastructure. There is likely a price where he would buy back stock, but at this point, he’d prefer to build net cash and wait for the right opportunity of size.
• But ASNA is also not a buyer any time soon due to (a) balance sheet cushion; (b) major initiatives still in process; (c) sellers are not distressed enough: Jaffe wants to be in a position of strength in a negotiation, and he’d prefer extra cash on the balance sheet, which means that their capex spend will have to finish (6-9 months). There are several me-too mall retailers that are in distressed situations, but I doubt he’s interested in those. Based on a prior conversation, I think he’d be interested in Claire’s (accessories for girls), but Claire’s is levered 9.3x EBITDA, and the bonds trade at 100.75 (for the 9% coupon). Jaffe will have to wait for this one.

Putting that all together, FY15 EPS estimates went from $1.25 to $0.96 (guidance $0.90 to $1.00) and instantly became a throwaway year. The CEO, at a conference prior to earnings, attempted to set expectations lower (“I tell a lot of shorter-term investors, we’re probably not the best investment for you”), but it clearly wasn’t successful. He has done nothing to talk the retail environment up since then.

What do you have to believe for this to work? Some combination of the following:

• Higher levels of profitability are masked by expenses related to the synergy projects. LB and Catherines are both being hit with duplicate overhead at this point.

• ASNA will get its synergies from the integration of its DCs and e-commerce fulfillment centers. ASNA achieved $23m of savings in 2014 (ahead of plan), and is expecting an incremental $30m in both 2015 and 2016.

• Once the synergy projects are done, capex will go down to $200-250m from $475m in FY14 and ~$365 in FY15. This has taken longer than expected, but it will happen.

• ASNA e-commerce sales will continue to grow and add ~1.5% to growth, which would be the same as e-commerce growing at 14-15%. These trends are still on track, and should get better with consolidated e-commerce fulfillment and once the Internet operations are handled in house by the brands.

• The weather (and comps) will be better next December-March. ASNA has a large percentage of stores in markets that were impacted by last year’s Polar Vortex.

• The tween shopper will come back a little bit (comps have been negative at Justice for three quarters in a row).

• Lane Bryant and Catherines will continue their turnarounds, which have both been going well under new leadership.

Key questions:

• Will Justice go the way of the teen retailers? I don’t think so, but it’s hard to have strong conviction in this.

• The trends for teen retailers have been worse, and teens have more discretion over money than tweens do. According to ASNA’s last commentary, Justice is already rebounding a little bit relative to last quarter (FQ414) – even with fewer promotions. Furthermore, Justice’s customer surveys have not changed from having them as the #1 store by a wide margin for tweens. In their most recent U.S. business, Claire’s was weak, but not as weak as the teen retailers.

• Is there still room for brick & mortar apparel retailers? YES

• The malls are starting to fight back. There are new services popping up such as Deliv that will do same-day delivery for a small fee from a local store. The large mall operators are working with these start-ups.

• The Omni-Channel concept (integrating e-commerce and brick & mortar) is important:

• Lane Bryant has ASNA’s largest online penetration at 18% due to their customer base. Interestingly, 50% of LB’s online business is from intimate apparel – but only 33% of their store revenues. These customers have gone into the store, gotten comfortable with a fit/size, and then just order more online. In addition, 50% of LB’s online sales are picked up in stores, where 30% of the customers make an additional purchase.

• From Macy’s (pioneer in omni-channel) regarding e-commerce fulfillment from stores: “helping our stores have more fashion, better assortments, and getting more four-wall growth in addition to obviously efficiently getting the goods to our Internet customer.”

• JCP (8/14/14): “30% of our online business is pickup in store.”

• For Dick’s Sporting Goods, 75% of their orders are shipped within 15 miles of a store.

• Smaller apparel retailers that do not have the scale to make IT and store infrastructure investments are being left aside. Body Central, bebe, Wet Seal, Cache, Dots, Coldwater Creek, Ashley Stewart, Love Culture, Loehmann’s are all subscale women’s specialty retailers without a significant niche. They are really struggling (first four) or have gone bankrupt (last five).

• Will all the capex spend in the recent past be worth it? There has been and will be a ton of capex spending from FY13-FY15. Some of these are no-brainers; others require trust in David Jaffe’s judgment.

• Synergy-related capex: $100m annual synergies for $200m over three years. No brainer.

• eCommerce project: Potentially $70m of improved pre-tax profits from $70m of capex. Plus streamlining their eCommerce and integrating store inventory is a must in this environment. No brainer.

• Office buildings: $155m of capex, ~$70m offset by sale of a warehouse, NJ tax credits, and MN state funding. Benefit should come from enhanced productivity in various parts of the organization, but the return is hard to quantify.

• Store-related capex: They have been spending more than maintenance levels to refresh the look at various chains as well as the Brothers (tween boys’ store-in-store concept) roll-out for Justice. Here as well the return is hard to quantify.

Valuation summary:

Even with negative store comps, the reduction in capex leads to a FCF yield of nearly 11% in FY16, heading to 17% in FY17. In this scenario of anemic revenue growth (from new stores and e-commerce), margin expands due to the additional synergies from projects nearly completed, higher margins from a greater percentage of higher margin e-commerce (from natural growth in e-commerce in addition to a FY15 project to improve e-commerce execution). In that scenario, EPS growth remains anemic too (due to rising depreciation), but the business would generate over $300m in FCF for additional acquisitions that can leverage the shared services infrastructure they just built.

Key Assumptions:

• Store-level comps = -1.5%

• Baseline e-commerce growth = 1.5%, which represents ~12-15% annual e-commerce growth

• Incremental e-commerce growth in 2016-2017: ASNA is in-sourcing e-commerce and implementing the ability to fulfill customer orders from stores, thus reducing stock-outs and improving inventory turnover from pooled inventories. Their research has shown that retailers who have rolled this out have seen a 5-10% lift in e-commerce revenues.

• Gross profit improvement from pooled inventories: Their research has also shown that retailers who have rolled out these omni-channel operations have seen an increase in gross margins of 50-100 bps.

  Additional upside (not included in the above assumptions) can come from the potential for EBITDA improvement from ASNA’s direct sourcing initiatives. Currently, a significant portion of Lane Bryant and Justice’s products are sourced directly, but about 85% of products for their other three brands are sourced through agents, which end up costing around 7% more. ASNA has been building up their direct sourcing operations over the past couple of years, and we should start to see savings from more direct sourcing in FY16 and beyond. This has the potential to add an incremental 10-15% on top of the current EBITDA level.

Catalyst

Improvement in overall same store sales performance (nice, but not necessary).

Gradual reduction in capex spend over the next 18 months (very likely to occur).

Acquisition of another retailer to plug into ASNA’s new infrastructure (probably not likely until sometime next fiscal year).

Initiation of buying back shares from $90m authorization (not likely until capex spend comes down more and FCF rises, but more likely if the stock stays at these levels when that occurs).