Ann Taylor Pulled from the Bargain Bin

By Linda McDonough

Shareholders of Ann Inc. (NYSE: ANN), owner of the Ann Taylor and LOFT women’s clothing stores, woke up to a pleasant surprise on May 18th when Ascena Retail Group (Nasdaq: ASNA), owner of the dressbarn and Lane Bryant brands, offered to acquire the struggling retailer for a 21% premium to its closing price.  Ann Taylor was the lucky one, plucked from the discard pile before stumbling down the rocky path of faltering retailers. Most shareholders of struggling retailers suffer the agony of a thousand earnings cuts as the stock withers away. Although private equity firms are often tossed around as potential suitors in retail, they often wait for the bankruptcy shingle to be hung before stepping up for a declining business.

Ascena is paying $47 per share for Ann Inc., composed of $37.34 in cash and 0.68 shares of ASNA stock.  Before the deal, Ann’s stock was up 2% in the past month. Compare that to Bon-Ton Stores (Nasdaq: BONT), a midwest retailer whose stock is down 22% over the same time period.  Francesca’s Holdings (Nasdaq: FRAN), once a Wall Street darling, has seen its stock wilt 11% and Bebe Stores (Nasdaq: BEBE), a purveyor of flashy women’s wear, has suffered a 23% shellacking.

Selling women’s apparel is a tough job these days.  Finicky taste and an addiction to sales have most female shoppers leaving stores empty handed. Although a squall of poor sales can often be temporary setback due to poor merchandising, many retailers fail to lure lost customers back to their stores.  Once sales start dropping, covering rent and fixed expenses becomes more difficult.

Ann Inc.’s Ann Taylor brand was once synonymous with a sophisticated career women’s suit, but the company has struggled over the past year and a half.  Comp sales, a measure of how stores opened for more than a year perform, fell 1.5% in the most recent quarter and 1.9% in 2014. The rules of office attire have shifted.  The once mandatory suit has been replaced with what the industry deems “separates”; skirts, pants and tops sold individually.  That must have blazer is now collecting dust at the back of customers’ closets.

Ann tried to adjust, introducing tailored but more casual work wear.  It began focusing more on its Loft brand which targeted a younger, hipper customer. Yet sales continued to stumble.  Investors patiently awaited the turn around as the stock treaded water for the past year. Earnings were down 33% in fiscal 2015 (ended February 2015).  

As noted above, Ann is lucky to have been picked up by Ascena at this point in its cycle. Both Bebe Stores and Bon-Ton Stores, retailers who have suffered poor sales for a longer time, are losing money.  Once comp sales turn negative, a retailer typically loses the ability to leverage rent and fixed administrative expenses.  Advertising and design expenses are typically cut and the company slips into a negative spiral of declining sales.

Although Ascena has dubbed the deal accretive, meaning it will increase earnings for the combined company, that is only because it was able to borrow the funds for the deal at such low rates.  If Ann Taylor’s profits are higher than the interest paid on the debt used to finance its purchase, the deal is accretive. While this financing strategy shows an immediate positive impact on earnings, it lowers the flexibility of the acquiring company by either draining cash or adding large amounts of debt.

The jury is out on whether the acquisition will be successful for Ascena.  Ann Inc. is Ascena’s fourth acquisition and its largest by far.  After acquiring Maurice’s in 2004 for $320 million, Ascena purchased Justice for $160 million in 2009 and then Charming Shoppes for $900 million in 2012. The total purchase price of Ann Inc. is $2.1 billion. Although Ascena has been able to improve profits at its acquired chains by consolidating IT, distribution and administrative costs, its track record of improving sales is not as clear. Justice, the tween brand that represents 32% of all sales has reported negative comp sales for 5 quarters and declining profits. It’s a stretch to assume that Ascena’s consolidation strategy is a one size fits all plan for success.

Around the Roadrunner Portfolios

Chase Corp. (NYSE: CCF) continues to refine its product line to ensure profitability going forward.  On February 2, 2015, the specialty chemical maker purchased two product lines from Henkel for $33 million.  One of these products is Dualite, a microsphere product used in automobile coatings to reduce emissions and enhance fuel efficiency.  Both new chemical lines are considered green products as they are raw materials that that help reduce water consumption and produce less greenhouse emissions in their final products.  This purchase follows the company’s sale of its Insulfab aerospace product line in October 2013.

Second-quarter results, released April 7th included only one month of earnings from the newly acquired product lines.  Growth of 2% in revenue should accelerate as Chase includes revenue from the new products for the entire quarter in the third and fourth quarter of this year.  Although gasoline prices have dipped recently, automakers continue to be on the hunt for ways to improve the fuel efficiency, a trend that should benefit sales from the Dualite line. Debt remains low as the company used cash on hand to fund their new purchase.  Earnings for the first half of the fiscal year equalled $1.18.  Excluding acquisition charges earnings were $1.22.  

Chase family members continue to hold on to their shares, with roughly 27% of total shares under their wings (page 2).  This includes the large holding of the  Edward Chase Trust. As industrial firms search for new ingredients to lower costs and improve the functionality of their products Chase should continue to prosper.  The stock, which is part of the Roadrunner Momentum Portfolio, is up 13% year to date and up 23% since our inclusion to the portfolio on January 20, 2014.

China Biologics (Nasdaq: CBPO) continues to be a superstar in the Roadrunner Momentum Portfolio. Although the stock is up 72% since our inclusion on January 13, 2015, industry trends point to continued and even improving fundamentals.

The company has benefited from the stringent controls on plasma production put in place by the Chinese government.  As one of the few approved manufacturers of albumin and IVIG, critical blood transfusion and inoculation treatments, China Biologics is reaping huge profits.

First-quarter financials, reported May 10th, saw revenues of $70.4 million up 25% and earnings per share of $0.87 up 26% year-over-year. Cash from operations for the first six months of the year was up an astounding 43%. A new manufacturing approval gained last December has allowed the company to ramp up production of its products.  Revenue from IVIG products comprised 47% of revenue and grew 60%. Cash continues to pile up with quarter end balances of $158 million and $92 million net of debt owed.

Although China Biologics’ livelihood is at the mercy of the strictly controlled Chinese regulatory framework, recent changes point to higher profits.  A recent ruling to deregulate retail price ceilings of drugs will take effect June 1, 2015.  To date, China Biologics has prospered primarily due to volume increases of drug sold, with pricing remaining relatively flat. On the company’s first-quarter conference call, CEO David Gao commented on this recent change:

Although it is still early to speculate implementation details and timeline for different regions or to assess the impact of the price ceiling removal on our plasma products, we believe this deregulation move should be a favorable policy development for our industry and business in the long term.

Expectations of 30% earnings growth in 2015 and 20% in 2016 could be conservative if prices for IVIG and albumin are allowed to rise. In the meantime demand from distributors supports continued growth. The stock trades at a P/E of 26 times the 2016 estimate, a generous but deserved multiple for a company growing so quickly.

The Greenbrier Companies (NYSE: GBX), a leading rail car manufacturer, was barreling full steam ahead into the third quarter of last year.  Demand for rail cars was already high due to the seemingly insatiable appetite of railroads to transport oil via rail. A series of fatal oil car explosions created the expectation that a second wave of demand would heat up for newly designed cars.  Anticipation and excitement regarding revenue from replacement cars sent the whole group of rail car manufacturer stocks to the moon.

However, the national debate over safety standards caused confusion for rail car buyers. Some standards were deemed too difficult to achieve.  Investors worried sales of new cars would be held up while the debate dragged on. Towards the end of last year the stocks seemed to have gone off the rails.  Greenbrier, which was placed into the Roadrunner Momentum portfolio on September 9, 2014, dropped a nail biting 40% in the two months following our recommendation.  The feared drop in orders while the industry awaited the final ruling did indeed materialize but was less dramatic than feared.

Happily, Greenbrier has bounced 40% since its 52 week low in December. While it is down 13% since our original recommendation, the stock appears to be out of the woods.  Final safety standards for rail cars were released on May 1st and should reignite delayed orders. Greenbrier praised the new U.S. and Canadian regulations.  On April 7th the company announced a robust second quarter with revenue increasing 25% and earnings tripling. Order backlog grew 14% from the previous quarter and is now triple its level one year ago. Management raised 2015 guidance to $5.80 from its previous level of $5.35. Although Greenbrier is a cyclical stock, this cycle will last longer than others due to the new regulations. The stock is cheap, trading at 10 times this year’s earnings estimate.

Lattice Semiconductor (Nasdaq: LSCC) is the second-most likely semiconductor company to be acquired in 2015 with a probability “above 20%” — according to a FBR Capital Markets analyst on June 4th.  M&A fever in the chip space is the result of recent takeovers of Altera by Intel at 8.7 times revenue and Broadcom by Avago at 4.35 times revenue. If Lattice were to be acquired at the lower of these revenue multiples (4.35 times revenue), it would be worth $13.33 per share — more than double its current price of $6.35.  Lattice CEO Darin Billerbeck responded to the FBR report by stating that the Lattice Board of Directors would seriously consider selling the company if an acquirer offered a “high premium.” 

After the Intel-Altera deal, Lattice and Xilinx are the only reasonably-large standalone companies left in the programmable chip industry. CEO Billerbeck said he did not think Lattice was an immediate takeover target, given the chip industry’s current focus on large acquisitions. “However, that can change rapidly,” Billerbeck said. A Lattice spokesperson later clarified that the company was “not for sale” at the current time (i.e., the company is not actively seeking buyers), but that Billerbeck was simply stating the obvious when he said that it would be management’s fiduciary duty to shareholders to consider a buyout offer.

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