Ascena Retail: The Future Looks Bright

In a tough environment, Ascena Retail Group (ASNA) reported another strong earnings quarter last night. The company saw flat or positive same store sales at each of the company's brands, as opposed to some competitors that have announced weak results due to the macro environment. These were very impressive results. Here's a look at the breakdown in sales:

(click to enlarge)

Source: Ascena Earnings Release

As, I've said before, the biggest thing you need to know about ASNA is that they have a best-in-class management team. These guys don't make unforced errors. You might not get the highest returns if you hold this stock, but it's a company that helps you sleep soundly at night, and I actually think you could see a 50% return over the next two to three years. Let's review more details about the quarter…

Update at Justice/Brothers

At Justice, total comp sales were up 3% in the first quarter, with both positive store comps and strong e-commerce growth. The company has been testing different marketing strategies for the business, including "flash sales," in which everything in the store is 40% off. During the quarter, the company ran a promotion with McDonald's (MCD) in which coupons for 40% plus an additional 10% off were distributed in Happy Meals. This promotion resulted in the significant increase in trial from customers who had not shopped at Justice before. The company opened 16 new Justice stores, including 7 in Canada and closed 3 during the quarter, ending the quarter with 984 stores versus 961 last year. The Justice expansion into Canada is progressing well (now up to 30 stores). On average, the Canadian locations are outperforming the U.S. locations in terms of both sales and profit. Next quarter, the company plans to open approximately 9 stores, including 2 stores in Canada and close 6.Overall, it was continued strong performance at the brand and nice results from expansion.

At Brothers, the company is encouraged with the progress of the rollouts, which are additions onto existing Justice stores. The concept was opened in 128 locations in time for Black Friday. These locations have seen no decline in girls business (Justice) and to-date are generating incremental sales in the high-single digit range. The company will continue to roll out this brand and expects to be in 150 or more locations by July 2014. This is a very nice incremental business which should continue to help the company in the future.

Update at Lane Bryant/Catherines

At Lane Bryant, one of the concepts acquired during the Charming Shoppes acquisition, total comp sales were up 7% strong store and e-commerce comp growth. Lane Bryant saw positive comps in all major areas led by intimates, footwear, Wear to Work separates, dresses and the newly-expanded Activewear business. The concept continued to transition toward more targeted promotions and increased focus on developing multi-channel customers and attracting new and reactivated customers. Lane Bryant's private-label credit card penetration also continues to grow, now at 43%, up from prior year. This is something that I really like because it helps the company during slowdowns as it's a more loyal customer base.

Catherines continued its turnaround (this has been one of the things analysts have been looking for) with total comp sales growth of 11% with both stores and e-commerce performing well. A strategy to rollout an updated assortment has been working. Credit penetration improved to 43% and membership in the segment's loyalty program increased 4%. The Catherines store count was at 390 locations at the end of the quarter versus 417 last year. Catherines will continue to trim its fleet in 2014, closing approximately 7 underperforming stores during the remainder of the year.

Update at Dress Barn

The other turnaround story for ASNA, Dress Barn, saw positive comps again (+1%) with store comps down just slightly and strong e-commerce growth. The key category drivers of sales growth were dresses, career bottoms and tops. Underperforming departments included suit separates, casual bottoms and jewelry. Private-label credit card penetration is now 32% of sales, up from last year. The dressbarn store count was at 842 locations at the end of the quarter versus 840 last year. As I noted above, the Dress Barn has been an underperformer but has now started to rebound. The turnaround at Catherines and Dress Barn again shows strong execution by the management team.

Big Loyalty Business

One thing I wanted to point out from the information above is the high penetration of private label card business:

"Lane Bryant's private-label credit card penetration also continues to grow, now at 43%, up from prior year."

Catherines - "Credit penetration improved to 43% and membership in the segment's loyalty program increased 4%."

Dress Barn - "Private-label credit card penetration is now 32% of sales, up from last year."

I think this is something that is very important for the business. We are in a retail environment that is very promotional as different concepts complete for customers. The high level of private label card sales helps insulate the company from these risks. These are loyal shoppers, and to see about 40% of sales at these concepts coming from private label makes me very confident in the business as we go through this highly-promotion environment and helps take some risk out of the ASNA story.

E-Commerce Making Big Strides

Another thing I wanted to point out was the growing e-commerce business, now up to 9% of total sales. Management noted that as this business grows, it is becoming increasingly difficult to separate e-commerce and brick-and-mortar sales. As mall traffic declines, it's nice to see strong execution by management on their e-commerce strategy.

New Chief Merchandising Officer

Another announcement on the call was that the company has hired Judy Langley as the new Chief Merchandising Officer. She comes to the company from Charming Charlie's, a jewelry and accessory chain, where she was Chief Merchandising Officer. Previously, Judy was Senior Vice President of design and trend at Kohl's, where she oversaw product direction for 15 brands. Judy has also held merchandising and product development positions at Ann Taylor, Banana Republic, Gap and Victoria's Secret.

Judy has been on board for like 11 days and it will take some time to see her ideas in action. Looks towards the fall of 2014 to see her real impact on the company. This looks like a great hire and I'm exicited to see the changes that come in the future.

Stock Buy-Backs

As I've noted before, management has recently spoken about buying back stock once their debt is paid off. To give some context, this management team only buys stock when they think their stock is very cheap. They don't do it just to like some other companies. After following this company for several years, this leads me to believe that management thinks the stock is currently cheap. I will note though, buybacks won't start until the debt is paid off, and management noted that the debt will not be paid off in the next 12 months, so we are probably looking about 15-18 months out before buybacks would occur. The company has no plan to issue a dividend.

I wanted to provide a quick analysis of where the company could/would buy back shares. The last time management bought stock was at $13, but that was before the Charming Shoppes acquisition. The company paid $890MM for Charming Shoppes (considering ASNA has about 150MM shares outstanding, that is about $6/share of value to ASNA). If you include $1/share of synergies and no debt (since it will be paid off before the company buys back shares), this means that at $20/share, the company would be buying the stock (this would be the company's bare-bones valuation). I believe that as the company continues to perform over the next 18 months, this level will rise to about the $25. If stock is at or below this level at that time, I would expect share repurchases to begin.

Valuation

We just highlighted that we can value ASNA through a sum-of-the-parts analysis:

1. Charming Shoppes - ASNA paid about $900MM for the company. At the time of the acquisition, I thought that if Charming Shoppes could fix its issues and return to more reasonable EBITDA margins, the company would be worth about $1.3-1.4B (this is one of the reasons why I thought the acquisition was a great move for ASNA; a great operator buying a company on the cheap with the ability to grow the value of the brand by 50%). Because of this, I believe that the value of Charming Shoppes 2-3 years out will be worth $1.3-1.4B, or about $9/share of value to ASNA.


2. ASNA - Dress Bar, Maurices, and Justice can make about $1.20 in EPS on a standalone basis by the end of FY 2015 (these units made $1.08 in FY 2012). Using a 15x multiple on these earnings, we get a value of $18 for this business.


3. Cash - the company should have about $2 per share and no debt by the end of FY2015.

This would give us a total value on the company 2-3 years out of $29 for the company. This analysis included no stock buybacks, which would most likely start to take place in about 15-18 months.

Risks

Risks for the company include:

1. Macro concerns- the company is planning for macro-economic factors to continue to pressure the apparel industry for the foreseeable future


2. Inability to fully integrate the Charming Shoppes acquisition - this risk becomes further mitigated with each quarter showing incremental improvement in the integration


3. Real estate risks associated with expansion - the company is looking both in-mall and off-mall for new sites, and will be prudent in finding good locations

Catalysts

Catalysts for the company include:

1. Margin improvement at Lane Bryant - this is the key for the stock to go significantly higher.


2. Margin improvements will give more credit to management's long-term low to mid-teen operating margin goal.


3. Continued turnaround of Dress Barn and Catherines


4. Expansion of the Brothers business and continued strong performance at Justice

Conclusion

Another great quarter for this strong management team. I'm happy to see improvements at each of the company's businesses. As I've said before, in the near-term there may not be a ton of upside, but I see this as a $30 stock in the next two to three years.

Source: Ascena Retail: The Future Looks Bright

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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. (More...)

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