What's Up With Ann?

By Will Ashworth | August 16, 2012 AAA

Just when you think retail is ready to throw in the towel, someone comes along with an earnings report that blows away expectations. Ann Inc. (NYSE:ANN) reported second quarter earnings August 17 that were exceptional. Only 30 months ago, its business was mired in losses and its stock was trading for less than $5. Today, it's within 7% of its five-year high and within 24% of its all-time high of $45.15 back in October 2006. Up 13.56% year-to-date, investors likely want to know if it can keep it going. I think it can and I'll explain why.

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E-Commerce
To be a successful retailer these days, you must have a strong online business. What constitutes strong? For me, it means growing quickly and delivering at least 10% of the overall business. In the first six months of the year, the Ann Taylor brand saw e-commerce revenues on a comparable basis grow 18% over the same six months in 2011. The Loft brand saw an increase of 22.4% in the first half of the year.

Combined, the two brands generated $125.7 million in online sales in Q1 and Q2; on a percentage basis, that's 10.9%. Breaking out the first and second quarter numbers separately, the Loft brand had a huge first quarter - up 29%, while its second quarter was not quite as impressive - only up 14.6%. The Ann Taylor brand was the exact opposite, with a second quarter increase of 29% and a first quarter improvement of just 9.6%. Most importantly, e-commerce sales in the first half of 2012, as a percentage of overall revenue, improved 130 basis points. If it can grow its e-commerce revenue as a percentage of total revenue by 1% to 2% each quarter for the next 24 to 36 months, its profits should be at least 30 to 40% higher, if not more.

Less Promotions
Avoiding huge chain-wide promotions in the second quarter by offering its customers lower-entry price points, Ann was able to deliver record gross margins of 55.8%, 90 basis points higher than the second quarter in 2011, also a record. Operating profits increased 27% to $52.9 million, which resulted in an operating margin of 8.9%, 140 basis points higher than the previous year. If it can maintain this level of gross margins, it should have no trouble hitting double-digit operating margins sometime in 2013. It hasn't done that since 2004.

Piper Jaffrey analyst Neely Tamminga believes Ann's fall and holiday offerings along with improved inventory management should continue to drive earnings growth. The company's exceeded earnings expectations for eight straight quarters. It's definitely on a roll experiencing higher full-price sell-throughs.

SEE: Understanding The Income Statement

Canada
Living in Canada, I'm very aware of the success American retailers are having north of the border. I've advocated for several years that more of them enter our market because we're ripe for the picking. In the past year, Canadian women's chain Tabi closed all 76 locations due to poor sales. Several others have downsized due to an inability to compete with Canadian retailers like Lululemon (Nasdaq:LULU) and Aritzia as well as many American chains.

Ann will open up two Ann Taylor locations in Toronto in the next two quarters as well as a Loft location in Toronto in the final quarter of the year. Not only is Canada's economy stronger, but the country is underserved when it comes to retail (23 square feet of retail space per capita in the U.S. compared to 14 in Canada), despite the influx of American and European retailers in the past few years. Not to mention annual sales for every square foot of retail space is $580 compared to $309 in the U.S.

SEE: Earning Forecasts: A Primer

The Bottom Line
The second quarter brought renewed strength to the Ann Taylor brand, as its smaller concept store is really gaining acceptance and its Loft brand continues to perform exceptionally. The combination should continue to drive a strong business into 2013 and beyond. An all-time high is likely too much to ask for in 2012. Look for it sometime in 2013.

At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

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