Ann Taylor Sales Drooping In Warm Weather (ANN)

By Edward Stavetski | May 25, 2007 AAA

Specialty women's-apparel retailer Ann Taylor (NYSE: ANN) has had a rough ride as of late. The company operates 869 stores in 46 states, the District of Columbia and Puerto Rico, under the names Ann Taylor, Ann Taylor LOFT and Ann Taylor Factory.

Fourth Quarter Trouble
In the fourth quarter of 2006, Ann Taylor, just like many retailers, had difficulty moving merchandise. Overall sales increased just 6.35% and this was due, in part, to an extra week in the quarter. Sales at Ann Taylor dipped 1% whereas sales at LOFT increased by 5%. Comparable stores sales declined 6% as the unseasonably warm weather pressured sales of sweaters and other cold weather accessories. Consequently, cost of sales rose 13.5%; in turn this caused operating income to tumble 29% to $30.54 million. Markdowns were rampant and operating margins declined 252 basis points to 5%. Net income declined 21.5%, despite a reduction of its income tax provisions. Most of the problems occurred under the Loft brand which had high inventories and a few fashion mishaps which forced heavy markdowns.

New Concepts
ANN is determined to resume its growth pattern and has some new changes for its different franchises. At Loft, ANN will focus on getting the product offerings correct and will also introduce a maternity line. Ann Taylor stores will unveil a new concept of beauty business and will offer fragrance, bath and body products through it. Ann Taylor Factory Stores are now transformed into full-priced stores which will help margins. After a two-year struggle management feels the company is reconnecting with its customer base. Despite the recent troubles in sales and margins, ANN has found its customer base to be stocky and has kept competitors at bay.

Building its Base
Over the past five of years ANN has invested heavily in its store base particularly the Loft. Overall sales growth is expected to be 9% to 10% over the next five years because of its new offerings and merchandise, new store openings and low double-digit same store sales. The company plans to open an average of 50 Loft stores per year. It also intends to renovate an additional 100 Ann Taylor Stores by the end of 2007.

Solid Valuations
Accompanying this sales growth, ANN expects operating margins to return to the 8.5% to 9.0% level. This should drive ROE over 15%. ANN generates strong free cash flow and holds nearly $400 million in cash on its balance sheet. Despite the inventory and sales issue in the fourth quarter, inventory levels are below a year ago. On a price/sales and PEG-ratio basis, both hovering around 1.0, ANN appears to be a good value.

First Quarter Results
As expected, ANN reported a tough first quarter, but the main focus was on guidance for the rest for the rest of the year. Sales increased 4.3% while earnings declined 13% to 46 cents per share. The major problems at the company stem from the LOFT business which experienced fashion missteps and saw comps decline 9%. There was an increase of 9% in inventories per square foot at the end of the quarter, due primarily to inventory in transit at Ann Taylor stores and the LOFT. Gross margins declined about 300 basis points which pushed operating income down 22%. ANN in the quarter repurchased 4.3 million shares at $163 million.

Outlook
ANN confirmed its previous earnings guidance. The company now expects comps to be in the low single-digits and overall sales to increase high single-digits. Gross margins are expected to rebound, which will only be partially offset by an expected 8% increase in SG&A expenses. However, gross margins in the second quarter are expected to be below last year's level, but will recover in the second half. Management remains comfortable with it previous full year guidance of $2.15 to 2.25 per share.

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