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April 6, 2005 Editor: This lecture is an excellent supplement and follow-up to the prior lecture on investing in retailers given in the link below. The speaker has a focused circle of competence and it shows in this lecture. GI = Great Investor GI Lecture on Investing in Retail Companies and a Retail Analysis of Ann Taylor Stores (ANN)
You can compare this lecture to the one here: http://csinvesting.wordpress.com/2011/09/13/lecture-5-a-value-investor-in-retaildiscusses-anf-aeos-aro/ Ann Taylor 2005 Annual Report: http://library.corporate-ir.net/library/78/781/78167/items/228474/2005AnnualReport.pdf Ann Taylor 2006 Annual Report: http://library.corporate-ir.net/library/78/781/78167/items/253110/2006_AR.pdf Companies mentioned in this lecture can be review with Value-Line here: ANF: http://www.scribd.com/doc/68791625/ANF-VL ANN: http://www.scribd.com/doc/68791928/ANN-VL ARO: http://www.scribd.com/doc/68792116/ARO-VL Wet Seal: http://www.scribd.com/doc/68792323/Wet-Seal-VL
Prof. and Great Investor (“GI”): Today we have a special guest, GI who has run a hedge fund, XXXX Partners, for the last 10 years with an extraordinary record. She invests almost exclusively retail stocks and some consumer stocks. She has had a tremendous record sticking to what she knows. In other words, her circle of competence didn’t have to be that large. She has been able to build a nice portfolio with huge returns over those ten years. And it shows that you don’t have to know many different things. Last year her pick that she discussed in class was Abercrombie (ANF) which went from $25 to $58.
There was a management change but in my opinion it was www. which is good and bad. and what her thoughts are now. Inc. I don’t know whether ABERCROMBIE (ANF)’s Spring line looks good. I focused on those companies easy to understand where you could get out there. I can’t say that a lot has happened in the business fundamentally that has changed from what kind of business they are running or who their customers was. I like the consumer sector.wordpress. You really don’t have to understand. If you can take a step back and see the big picture. touch. you are getting a ton of information coming out of these companies on a monthly basis. for example. there often a lot of opportunities out there. So ABERCROMBIE (ANF) is a case in point if you look at their stock chart and you can go back a year ago you could have doubled your money between then and now. 2003. Sold in Mid-$40s. like same store sales (SSS)--Store sales of stores that have been opened for at least twelve months. If you have a value orientation and a longer term orientation—when I say longer-term I mean one to two years because people are mostly focused on the next months’ numbers. what you have to get right is if management knows how to run a business. And that doesn’t matter and that is the beauty of it. I could get the customers’ understanding and get their feedback. You get to buy things when people are often trading them.csinvesting. (NYSE-ANF) for purchase on Oct 29. ―Whether management get the right denim skirt doesn’t matter. I like to shop. Another thing I really like about retail is that you are getting a lot of info and it comes out on a monthly basis.com studying/teaching/investing Page 2 . feel and understand. I can’t analyze what the next hot trend is. So it is one of the easier sectors. I really wanted to find a niche for myself. It is bad because it creates tremendous volatility in this sector. but that is the reason it is good. GI will discuss her current idea. Because you get the opportunity to buy things when they are unfairly cheap. how to evaluate it. are they generating good returns on capital? And if they miss so what? I get another chance next season. Something I could relate to. GI: I will talk a little bit about how I started and why I went into retail. Unlike other industries where you are getting numbers on a quarterly basis. in my opinion to understand and analyze. And a lot of people hate this sector for that reason.Lecture 9: A Value Investor in Retail Discusses ANN GI discusses ABERCROMBIE & Fitch. And they certainly are not going under in the meantime.
FORTUNE's Julie Schlosser phoned Berman in Cape Town (where he spends three months every year) to chat about the sector's latest batch of strong sales reports." says hedge fund manager and onetime accountant David Berman. And I think weather has been a positive factor. negative 9. why they don't necessarily bode well for stocks. People throughout the industry could not focus on what type of business they were running. look at this business!‖ This is a great business and all of a sudden people were not just focused on the SSS but on what the actual business was doing. It was about four degrees warmer than usual across the country in February. negative 5. His choice? Retail. perhaps there are merchandising issues here. Every time I sold. retailers. Basically he said: I have my people visit stores and malls to see how much the items are marked down and how long the lines are at the registers. 2005 Hedge fund manager David Berman profits by thinking like a patient predator. but I can see they run a good business and if they could stabilize that comp. "Every time I bought a stock. March 22. I'll buy a stock if I think the company is going to beat numbers and short it if it is going to miss numbers. His specialization strategy has paid off: Berman says he has averaged a return of 17% after fees over the past eight years with only three down months. Despite lackluster holiday sales.Lecture 9: A Value Investor in Retail Discusses ANN not significant. Perhaps tax refunds are better than people thought they'd be. ―Oh wow. There are a bunch of theories why. It is that simple. you could have taken a step back and said. someone smarter was buying. This article (included below) interviewing a money manager who covers retail stocks and his quote is very similar to how a lot of people think about retail stocks and how most or all of the sell side thinks about retail stocks. He now manages more than $100 million through Durban Capital. inventories at U. And they were generating EBIT margins close to 20%. It surprised me. But to a large degree. amongst the highest in their peer group.csinvesting. A big part of his formula is that he's willing not to buy if prices aren't right.wordpress. but what was happening for a good year and a half prior is that they were generating negative same store sales (SSS) and negative comp store sales. Fashions are pretty good. someone smarter than me was selling it. if they could just generate at the bottom of those comp numbers—they were running negative 9.com studying/teaching/investing Page 3 . "I used to be a victim of people like me. Berman decided to focus on a single sector and master it. I recognize that comp store sales are negative. during this time of year the retail group gets moved for macro reasons. Can retailers keep beating expectations in 2005? February surprised everybody. INVESTING: King of the Retail Jungle FORTUNE Tuesday. retailers included. Which macro factors affect retailers? www." So when he formed a firm to manage his own money in 1997. and what investors can learn from crocodiles. a hedge fund he named for his hometown in South Africa and launched in 2001. In 2002-2003. the S&P 500 retailing index is up 11% for the past year. people thought. This son of a furniture maker spent a year walking malls and eventually developed a custom index—the DeeBee (as in David Berman)—to compare sales vs.S. And all anybody could focus on was on whether their next comp stores sales was negative. but once they could stabilize their comps.
it gives us a great sense of which companies are going to do well because their inventories are well controlled and which ones have potential for missing numbers. Ann Taylor Stores (ANN) announced plans to acquire May Department Stores. Almost one in every ten sales in America is done in Wal-Mart. That's why I measure inventories. It is that simple. You can't lose money if you're in cash. As a result the department stores are really being squeezed.csinvesting. I'm not a bond expert. They're having to scramble to stay www. That means I am half in cash. And roughly 8% of total sales. The crocodile can go for almost two years without eating food. to know what the P/E should be. That has totally changed the retail landscape. You want to be like the crocodile and wait for the prey to come to you. And it also gives us a sense of the future strength of the economy. some of my investors will be upset with me. My job is to understand what the EPS [earnings per share] should be. Last month Federated Department Stores. I've never used leverage.com studying/teaching/investing Page 4 . Is it a sign that the department stores are truly dying? The merger is a function of Wal-Mart's power. You don't want to rush off to the prey. and that will slow things down. What do you mean when you say you use a "Crocodile Approach"? Just wait and be patient for the right opportunities. How do you figure out if a stock is a good value? I maintain that I am not smart enough. On an individual level. It has very small legs and can't go very fast. Your DeeBee index measures sales growth vs. but until recently I rarely had much more than 50% of my money invested—both long and short—at one time. because retail leads the way. but it is really worth it to us.wordpress. We've been doing this quarterly for many years. If it is the best month for retail. If inventories are depleted what does that mean? It means retailers are going to be ordering faster. but bond yields are going to do the job. and that means the back end of the economy is going to do well. If its prey doesn't come. It gives us a sense of the profitability of the group going forward. Wal-Mart by our numbers has 21% of the sales of publicly held retailers. Home loans may start going higher. what happens to interest rates? They go up. I recognize that is too low. It waits by the riverbed. Greenspan has been very ineffective with raising rates. I've never been afraid to build up a big cash position. That's why I don't have many down months. In fact. The Fed hasn't been able to slow the economy down. And that's not good for retailers. That's almost 300 companies. parent of Macy's and Bloomingdale's. The rates have gone up to over 42%. I'll buy a stock if I think the company is going to beat numbers and short it if it is going to miss numbers. It needs to increase. Is that how you predict whether a company will beat Wall Street's earnings estimates? We summarize every publicly held retailer in America. With that in mind. But the long range is out of his control. You may have that now. It is a lot of work. I look for facts. I have my people visit stores and malls to see how much the items are marked down and how long the lines are at the registers. inventory growth. You want to wait for the big zebra and grab him and eat it up. But it's because of the Crocodile Approach.Lecture 9: A Value Investor in Retail Discusses ANN Sometimes the best months for retail sales have been the worst months for stocks. and I don't think anyone really is. it just sleeps all day. but those yields may well go higher because this economy is really rocking. Or at least people think it's rocking. excluding autos.
which has been a great growth vehicle for them.Lecture 9: A Value Investor in Retail Discusses ANN competitive. That bodes well for future margins and profits. But a large amount of that is reflected in stock price. And you will read any analyst report. waiting patiently for opportunities. particularly a year ago in ABERCROMBIE (ANF). It is probably just a natural evolution of the retail landscape. Once again tremendous opportunity here if you are looking at the right stuff. GI continued……… And I say to you that1 is your opportunity. They are firing on all cylinders. GI: They definitely were having merchandising issues and they were really having trouble finding what their identity was. American Eagle Outfitters (“Eagle” AEOS) Student: What has happened with this brand? AEOS changed their merchandising. The problem is that those results are already factored into the stock price. They've beefed up their staff over the last couple of years. ROIC was high teens after-tax. $29). As opposed to what the company was doing and how productive their store base was. $55) also had good results. Or analysts will focus on what the stores looked like in March and April. Remember.11x EV/EBIT. with sales up 9% and inventory up only 2%.csinvesting. Many companies are looking worse this year in terms of inventory growing faster than sales. There is just a slow deterioration in the department store mode. They just hired some good people for a new concept that they will be announcing soon. I own it. That's the best in the department store category. I'm in sleeping mode. It creates so much volatility and so much opportunity for you. It will give them another leg of growth. End of article. So the crocodile isn't running out to snap up zebras? I am really concerned that the retail group has had a nice run. It is that simple. ABERCROMBIE (ANF) 1 Take advantage of Wall Street’s short-sightedness studying/teaching/investing Page 5 www. There are so many people out there doing that whether they miss their numbers or not. At the top is American Eagle Outfitters (AEOS. But they had tremendous growth—not so much in their core business--but in their Hollister business which is their secondary business. It just reported sales up 37% while inventories are up only 14%. It's hard to find good longs.com . Now they are more surf oriented than conservative. They were being squeezed at both ends. What is the DeeBee index's top-rated stock right now? I can tell you who is good on my inventory list but they might already have a high P/E. but I've been reducing my position.wordpress. American Eagle has got great management. Nordstrom (JWN. the concept of who is going to beat earnings and the stock price are two different things. Student: What was the EV/EBIT multiple for ABERCROMBIE (ANF)? GI: It was at 7x but our target was 10x . they (Wall Street Analysts) talked about the ABERCROMBIE (ANF) core business and the fact that it couldn’t generate double digit SSS as they had in the past.
but they were also shook up their merchandise team in order to improve their merchandise offering. what might have been attractive to you is that the EBIT margins were trading in the 8% range and two years before the EBIT margin had been in the 12% range. While on the lower end. they say they can open up to a 1000 stores. you can see the stock has doubled. About a year ago you would see. Student: What you had to get right in this story was to get the merchandising sales trend correctly.5 years. They also had some little help from their competitors when ABERCROMBIE (ANF) simultaneously announced that they wished to go more upscale.wordpress. JG: Why is it trading at such a high multiple? LG: Because they are generating great comps (SSS). It has gone from $5 to $30 over the past 2. There could be a lot of opportunity here if they could just get it right. in spite of no new growth vehicle. And what has happened during that time. people basically had written them off and had decided that they were never going to regain their footing. But the other thing people started to take notice and a stock that was trading at 8xs back in 2003 is now trading closer to 17xs—or over a 100% earnings multiple expansion. So Eagle had a couple of things working in their favor. they had negative comps. What happened during that time. if you looked at EBIT margins.csinvesting. So are you not having to guess on future growth in SSS? www. So they wrote it off. If you notice in the store count which is on the bottom line—they are pretty saturated. but there are only so many malls that exist.Lecture 9: A Value Investor in Retail Discusses ANN was at the higher end–the kids who wanted to shop ABERCROMBIE (ANF) and wanted the ABERCROMBIE (ANF) brand. The point being that when these stocks are in favor. people focus on the wrong thing. ABERCROMBIE (ANF) as you might have remembered from the last slide was in the 18% to 19% range.com studying/teaching/investing Page 6 . At the time if you had looked at it. they have improve their merchandise and some of their competitors have moved away so they are not competing head on. People had written them off. ABERCROMBIE (ANF) has gone a little older and a little bit higher end by putting in higher price points. So they really needed a new growth vehicle—having said that. Skip forward 6-8-12 months later. Eagle has tried to focus on the high school customer. Student: What happened to store count in 2002? 2000 790 2001 864 2002 915 bought a Canadian Chain 2003 846 2004 887 Stores GI: What happed was they bought a Canadian chain and basically blew it the moment they bought it. they were being hurt by Aeropostale (ARO) where they couldn’t compete with those prices and ARO was knocking off a lot of what Eagle was doing. the stock is still trading at 18x to 20xs. when Eagle’s price was at $13 to $15. Basically the common stock was trading at 8 times earnings. If you ask them. those margins were headed down to the 8% range. Eagle had defined a niche for itself.
What happened is that they were all over the board. I am still in business. though.csinvesting. Definitely what you were starting to see is they were going to focus on a particular customer. another thing went in their favor was an external factor in their industry. but they were at an 8% EBIT margin and a couple of years earlier they had 12% margins when they had run things just a little bit better and their closest competitor (ANF) was at 19% margins.com studying/teaching/investing Page 7 . If you have a two to three-year horizon and you say look I still have a pony on the track and it still is running and the race is still going on. I am not going out of business. they close factories. as I said. www. Plus they knew they were having a hard time competing. That is what happens here in retail. but they were still earning some money. So if you buy them cheap enough. This smells like opportunity to me. What you have here. Professor: Let me add to that. So the question was—the great thing about retail is that if Spring stinks (their merchandise assortment of customer acceptance). You see it went from $5 to $30. is a company that definitely has a customer base. because actually they did everything wrong and they ran an 8% EBIT margin. They were not going out of business and they had a strong balance sheet. So if they laid out a five step program to improve—well if they get two or three of those points right. they shook up their merchandising team. They were focusing on the 20-year old kid. they didn’t have to get it right in this short of period of time. They were doing everything wrong. Here it was trading at a low multiple of depressed earnings. When Rich Pzena was here. then Fall will be better or Winter. on the 15-year old kid and they really couldn’t get their focus down and that was largely in part to their merchants were not being able to target their customer well. he said low ROE companies make changes: they fire management. So the answer is—I didn’t know for sure they were going to get it right.wordpress.Lecture 9: A Value Investor in Retail Discusses ANN GI: It is the fact that they (management) recognized that they had issues. And. there is certainly a big upside opportunity there. They do stuff because it is not working (The Board of Directors or new management make changes to improve or stop losses).
Student: Do you look at retail like cyclical companies when their earnings are depressed they might have higher multiples? GI: Again the answer is that people love to beat up these things up. If you are playing for a $5 to $10 return. maybe they have the platform to really do it. If you had walked into their stores last Christmas and they couldn’t give stuff away. you don’t have to be playing for a return of $5 to $30. Then the stock can trade at a greater multiple—10 to 12 xs—off a greater earnings base. 2 Note that the speaker is talking about normalizing those depressed margins. And if they continue to be this bad and they still are generating some money and you could see that the stock is trading at a low multiple. the low end of multiples is 8xs to 10xs and the high end is 20xs time range—P/E multiples. So that also gives us some security to last through the bad times.Lecture 9: A Value Investor in Retail Discusses ANN This season stinks. but next season won’t. there are not a lot of growth prospects and it is trading at 17xs . maybe they are going out of business. she bought at $25 on sort of on a similar thesis and now it is at $58. I can tell you having lived through when a comp sales posts a negative 15% comp. Then all of a sudden you get your returns from $5 to $10 which is a pretty good return. then can it get any worse? Or they could get a few things right? And if they get a few things right. who would care? When people see things on a negative trend. Things are going well. or one year thing. Because these were incredibly depressed earnings2. you are a contrarian to the other guys. GI: That is how I like to look at it. these things (retail stocks) just get battered. studying/teaching/investing Page 8 www. but when they get it right. then people will start to sit up and take notice. Everybody’s thing with retailers is--because what is their reason for being? If another retailer fell by the wayside. (You are getting a double upside from both an increase from depressed earnings to normalized earnings and a multiple expansion as other investors gain confidence). they write-off and sell their stock when they see the bad numbers in comps? GI: Psychologically when you are seeing month after month of negative numbers it is tough not to panic. Student: Investors once they see a downtrend.wordpress. Here you might argue (with AEOS) this is slightly overvalued. So having followed retail for as long as I have. Professor: When GI was talking about ABERCROMBIE (ANF) which she did own. It really is tough to take a step back and say it is a one season thing. People love to write off retailers.com .csinvesting. Student: So when of your edge is that you are so patient. A lot of retailers these days carry a lot of cash.18xs so you probably don’t last till then. She sold out in the mid-$40s. not to say. there is so much potential and the operating leverage is huge. Maybe we will hire this guy. which is still a pretty good return (80%+). I take a long term perspective in an industry which people feel doesn’t warrant that. maybe no one will go back into the store.
One they sold. Professor: The answer is no. What is happening now is that they are closing a good portion of their base of unproductive stores and they are going to try to give it a go with some of their more productive stores.csinvesting. They are really getting back to basics. They really ran into a problem. at $4 it could be a good play. If they can keep their head above water while they get their act together. GI: You mean Slutty teenagers? Wet Seal is a company that definitely. They want to simplify. At the very least. www. If the sales go down. A potential turnaround. they were running three different concepts. Student: Look at company Wet Seal. they have closed many of their money losing stores. the profit goes down. and a lot of their stores were unproductive. How do you know if it will survive or not? A turnaround? Student: Wet Seal is another teen retailer to teenage girls that is just about bankrupt.wordpress. But the hope now is that they have pulled it down and gotten back to a manageable size and back to a simple business. You mention the volatility.Lecture 9: A Value Investor in Retail Discusses ANN Student: The industry is pretty leveraged given the capex for the stores.com studying/teaching/investing Page 9 . another they closed. Have you thought of using the option pricing model to price stocks? GI: I like to keep it simple. they opened way too many stores and stores way too large and ran into a problem when their comps turned negative. They got rid of their two other operating chains. They were a 700 store chain. They will try to give it a go with their more productive stores and give it a go with their smaller store base. But what really came out was that they had a large number of their stores that were unproductive.
The way you look at it is: for the most part there are A. But in ABERCROMBIE (ANF) it will not work in a C mall with their (high) price points and it won’t work in every B mall either.Lecture 9: A Value Investor in Retail Discusses ANN Student: Do you know when these companies store concept reach saturation? GI: It really depends upon two things. in ABERCROMBIE (ANF) when they rolled out Hollister. Some do well and others don’t. Your job is to figure out if that (management’s expansion plans and store growth) is realistic or not. Eagle. Student: Say if ABERCROMBIE (ANF) has a margin of 20%+ what is its sustainable competitive advantage (SCA) and what gives you confidence that ABERCROMBIE (ANF) can continue to have high margins? www. It was not as much a margin play with ABERCROMBIE (ANF) because margins were already way up.wordpress. Student: There was fear about cannibalization between brands in ABERCROMBIE (ANF). And look at other competitors if they can open a number of stores. I like to see a good growth opportunity but there are plenty of situations where they don’t have much square footage growth left. And I think of those opportunities as equal to the growth opportunities. margins did not fall apart. And knowing that you continue to look at margins as they roll-out. So ABERCROMBIE (ANF) will max out for the core division in the 400 to 500 store range. ANN has their core brand and they have a newer concept called ANN Taylor Loft--that when you open a new concept that is 30% cheaper than your core concept. Yes. then there are street and other non-mall locations. How did you get comfortable that they were not hurting the more expensive brand? GI: The arguments people make—I am going to talk about ANN Taylor in a little bit. how can you make money at both and why won’t a customer go from one concept to the other because it is cheaper? And the answer is you have to be comfortable with the fact that management has differentiated the concepts enough that you are really dealing either with two different customer bases or you have a customer who is willing to buy both. Customers would go to Hollister to buy a cheaper version of cargo pants rather than shop in Abercrombie. I understand why 1000 stores make sense. it was not the result of Hollister. Then there these things called Life Style Centers. Where ABERCROMBIE (ANF) has lots of growth left in their Hollister unit and that is why I really like ABERCROMBIE (ANF). You can make money both ways. You have to know who your customer is and what the price point is. Student: In addition to Comp store sales are there any other metrics you look at? GI: I will get to that. doesn’t have the growth left. but Eagle’s play was just getting the growth of what they had back to the operating productivity of what it could be and should be. Every time a retailer rolls out a new concept that is the argument against it. you do have to do the work and develop a level of comfort. And. In Eagle.csinvesting. because their model works in every one in these different category malls. but they have plenty of opportunity to get their current business right. You can definitely make money in many different situations. which is a lower price point store. So you can look at an Eagle and say. can have somewhere in the neighborhood of 900 to 1000 stores. B and C malls. on the other hand. So even though comps were down in Abercrombie. I think there are two ways in the examples of Eagle and ABERCROMBIE (ANF) where you could have made money in both of them.com studying/teaching/investing Page 10 . You have got to look at the competitive landscape and find out who is their customer base. For example.
There are reasons it is cheap at that time. You will see. but we are actually looking to generate good returns on capital that we had in the past. They just couldn’t just open stores. We can’t start by cutting prices and having our customers expect to shop on sale every time they come into the store. ABERCROMBIE (ANF) has built a premium price point brand where they can maintain their prices and that is why they have such phenomenal margins. But management responded by saying. They had to develop marketing. The concept generates the kinds of returns that are excellent returns. we miss it. It is almost making it seem harder than it is in a way because when you miss you don’t lose much money because you bought it cheap. Student: I imagine it has to be more than just management because then a couple of people could go and start as competitors. They tested the concept. it is beat up. And the whole idea of doing what we have been doing is that if you are right and you say this could trade at 50% to 100% more and then where it is and if you are wrong and you don’t lose money. then they would have to build another brand. but you don’t lose much money www. GI: Everyone was telling ABERCROMBIE (ANF)--when it was a very competitive and promotional environment last Christmas when Eagle was promoting everything out of their store--to drop their prices. that is a pretty good risk/reward because you really didn’t pay up for those opportunities.000 sq. GI: I would like to move on to Ann Taylor Stores (ANN). Part of it is building a brand. If you think that this is a management team that happened to luck into a great concept in ABERCROMBIE (ANF) and they are willing to launch a new concept that is going to be dilutive—I don’t think that is the way these people think. ―You know what. Management is thinking how can we develop a concept with the best bank for our buck? We are not just looking to grow the store base or the sq.‖ If we miss this season. ft. it is cheap. What is the competitive advantage beyond management (so as to be confident of the company’s long-term advantage?) GI: All I am saying is that they have a concept that works. They understand the formula and they will try to duplicate that formula in another form. One thing I can say is that when GI buys stuff. You don’t have to be right all the time. in the next example. they built the brand and then they expanded it. Just based on their track record—back to your question--it gave me the confidence that they (management) wouldn’t launch a concept that would not generate the type of returns their core concept had. So there is not any single formula—Oh.Lecture 9: A Value Investor in Retail Discusses ANN GI: You to have confidence in the management team and that they are thinking the right way.com studying/teaching/investing Page 11 . They had to develop something that spoke to their customer base and gave the brand legitimacy.csinvesting.wordpress. And they knew if they launched another concept. you will never sell anything. she is not buying the company at 17x earnings with fully built out stores with no new concepts. and then she can answer more questions. and they specifically told everyone and made the decision that they were not going to dilute their brand by lowering prices. Or you can hire these people. So they could have gone out and opened 400 Hollister’s but they went out and opened 20 Hollister’s. we have to maintain the integrity of the brand by maintaining prices. store with an average price point of X is the formula. So you are saying it could be wrong or it could be very tough to figure out whether they can maintain this. footage. Professor: ABERCROMBIE (ANF) had the chance to knock down prices. a 4.
Lots of people have lost their shirt shorting it.3 11. And you could make 50% to 100% if you are right and you are right more than you are wrong.2 ANN 359 Loft 343 Concepts Fact 36 738 Outlets 24 Super loyal 1049 TLB $32. “Buffett-type” franchise companies.790 255 105 1858 1 13. So when she talks about Ann Taylor Stores (ANN) you will see what this opportunity is and it may work or it may not. J. That has been. J.27 273 54 15 0.3 11. ANN TAYLOR STORES (ANN) $25 $1.4 Misses 519 Pettit’s 286 Add Stores 112 CHS $28 $5.wordpress. Jill. www.5% pre-tax return) and think that it is not cheap. So I think—these are difficult questions to answer—GI is an expert in this field. Jill will lose money.044 266 224 5. If you are right you can do quite well.5 Chico’s 511 WH/BM 167 Soma 167 688 JILL $13.7 J.2 16. where they will land. And if you are wrong you don’t lose (much) money. unfortunately. one of the best performing stocks over the past ten years. So I think the answer is you make a good guess based on everything you have seen: ―Is the management good? Does the brand look good? Are their customers loyal? And things of that nature. At first glance you may look at EV/EBIT (13x or less than 7. And probably if you stopped here you would not buy it.3 11.43 $1. but she limits her losses and she knows opportunities when sees them.com studying/teaching/investing Page 12 . 2006 is really a made up number because nobody knows if they turn it around.5 10. GI: When you want to buy something cheap. Again the numbers don’t look very cheap.826 (68) 1411 1. But you can see the risk reward is tremendous each time. then the math works. It is not quite as hard as getting it right every time.5 13.5 -32. That could potentially be an interesting story to look at because there is enough opportunity.Lecture 9: A Value Investor in Retail Discusses ANN if you are wrong. I put up some of ANN’s closest competitors which are Talbot’s (TLB) and Banana Republic.csinvesting. The discussion above is similar to the difference between buying “cigar butts” vs. She still is wrong sometimes. But I think it is one of these things you have to delve a little further to understand why it may be potentially interesting. but I don’t think it is cheap enough. If I said to you which one would you buy? The answer would be based on this would be NONE of them because none of them look cheap. Jill 150 Price Market Cap Cash (net) EBIT (LTM) EV EV/Sales LTM EV/EBIT 2005 EV/EBIT 2006 A couple of others that cater to older women are Chico’s and J. Jill will lose money and this year is a turn-around year for them. Certainly you might even look at Chico’s and say you would want to short it.
And they have a lot of street locations so they are not just limited to being just in malls. What I will tell you is in this same timeframe LOFT which is about half of their store base has done extremely well. but actually ANN’s peak EBIT margins were north of 12% and that is even low for the industry. but has there been a fundamental shift in the business? What has happened? GI: Right now this is like a special situation. I only went back to 2002 here. The good business can double in size (LOFT concept) and the bad business has done a lot better in the past so you can earn a lot more from www. These people are good operators. I could tell you that ANN has a lot more square footage growth potential over the next five years than TLB.wordpress. which we looked at earlier. WHBM is White House Black Market which is a new chain that they have launched and there is growth left there. Talking about ANN at first glance it doesn’t look cheap. They have grown their core concept relatively slowly.com studying/teaching/investing Page 13 .Lecture 9: A Value Investor in Retail Discusses ANN Student: What is the story with Chico’s – Why has it performed so well? GI: They are great operators and they have really found their niche. You don’t want to get in their way. Well they went from 12% to 6% margins. So you have lots of opportunity (for improvement). a year ago they were basically giving everything away. you can look at this and say lots of opportunity here based on what they have done historically. They have honed in on their core customers and created a very loyal customer. Now management won’t break out margins for you between the two concepts but I will tell you that my guess is that they are at least in the 11% to 12% operating margin range. Looking at the bottom of the table we are talking about concepts –growth opportunity-in their core concept they are at 359 stores.csinvesting. In Christmas like Eagle. There is some growth there. Anybody know anything about Chico’s? Student: They cater to _______ and it is a growing demographic and it is an underserved demographic. Management is trying to get the ANN Taylor core chain back on track. And what has happened now is that there have been some management changes that have taken place. One of the nice things there is that they launched Loft about five years ago and it is almost matching the size of ANN and they could more than double their Loft store base from where they are now because they are at a lower price point. Like ABERCROMBIE (ANF). They probably get to the 400 stores level because they would max out their store base because they have a higher price point. Why didn’t Talbot launch a distinct concept? The truth is at 1150 stores they will max out on their square footage potential a lot sooner than ANN is going to max out. GI: They have done a great job at creating a super loyal customer base. they did. So why do I like ANN? ANN is one of those stories where everything they could do wrong in the past year in 2004. So despite ANN and TLB looking similar. As you will see from what ANN did in 2004 that means the ANN Taylor chain must really be doing lousy if they half the chain is doing 12% margins. They did 12% operating margins when they only had the core ANN Taylor concept.
then there is a possibility for a $45 stock price from $25 with $2 or $3 downside. if they (mgt. We were buying it in the $21’s. Is it trading cheap enough so that if they don’t get it right will I lose my shirt? The answer is in the mid 20’s you have a couple of points down here.50 per share to north of $2 to $3 the following year assuming if they can fix these business. But look at the numbers. but I still think there is tremendous upside because if you just take a look at what Street Estimates are for this year and next.csinvesting. You can double the size of the good business. The bad business is masking the good business.Lecture 9: A Value Investor in Retail Discusses ANN the bad business. They (Wall Street Analysts) are assuming very little gets fixed on the ANN Taylor side. is to ask where do these things trade when they get it right? And as we said it trades at 17xs to 20xs when they get it right.7 2007 $2.com studying/teaching/investing Page 14 . They can go from the assumption of earning $1. Even knowing nothing about this company it is realistic based on what they have done in the past and what their competitors are doing. Look at what happens to the stock if they can get their business fixed. What you can analyze is where has this company been and where does it have the potential to go if they do get it right.482 $2.3 You have a lot of plays. It has come back a little bit off its lows. Even if you don’t know much about their business and who this new management team is that is coming into place and what their new merchandising initiatives are. Ann Taylor Stores (ANN) Revenues EPS Pre-tax Income 2006 $2.wordpress. nobody is putting back margins to 10% to 12% in 2006. www. LG: The stock has gotten hammered. 4 The speaker is mentioning the ―art‖ of what terminal value (multiple) you place on earnings. They have not made that public yet. you can still look at the historical record of their company. but that is sort of a free play so we are not even counting the new concept. I think 10% operating margin or 12% operating margin one to two years out is realistic.854 $3. I think that is a pretty good risk/reward4. Another way to look at it is to look out to four or five years and ask what potential type of buildout do they have? And what type of cash can they generate? And what will their earnings be at the end of that five years? So they can still continue to grow square footage in the 13% to 15% range over the next five years that just by opening Loft stores and a few ANN stores not to mention that they talked about opening a new concept.) do reach 10% to 12%. but you have a lot of good upside--$3 or $4 downside for $30 upside. It is now up to $25. 2006 E 938 379 2007 E 1038 389 Stores ANN 3 In your analysis. and people see in the coming year that the $3 in EPS is a reality. You know I don’t want to assume a 20 multiple—the absolute top. products.00 $342 One of the ways to look at it when we looked at ABERCROMBIE (ANF) and Eagle. and concepts. Let’s be conservative and say that it trades at 15xs. The point being is that when you are looking at those EV/EBIT numbers that didn’t look that great--those analysts’ numbers are really based on low estimates. Nobody is going out on a limb. you always want to break apart businesses to see the differences in divisions.17 $253.
the company at the end of the five years on the current store base--they would be earning $1. If they can fix the ANN stores and get back to 12% margins while the ANN Taylor Loft stores are already there. This one is very easy to see over the horizon. Right? That is not so hard and you can figure out these numbers. Student: They did everything wrong? How do you gain confidence that they have not permanently damaged the business? LG: The business fell apart in the second half of the year. Analysts will say a company will grow 15% a year—they may even be ending their growth 2 years from now so it is crazy to think of it as a 15% grower.wordpress. what this plays out means is that it will be very clear that they will be able to build out the ANN Taylor Loft stores. this is how far they can expand out the concept. They made some huge merchandising mistakes—it can happen to anybody. and he also was going www. You get $45. They have now gotten rid of the guy who was doing the merchandizing.70 EPS.Lecture 9: A Value Investor in Retail Discusses ANN Loft 493 568 So just from the Loft and ANN concepts we have got 13% to 15% sq. So if we build it out to its potential and we assume that the company can get back on track and operate in the 12% EBIT operating margin range.com studying/teaching/investing Page 15 . He (former merchandising managers) brought in the wrong merchandise. you have accumulated $10 in cash during that time assuming they did not buy back stock or else you would get a bigger bump up.70 instead of the $1 they earned last year.50 and if you build it out. LG: It is a compounded 17% annual return over the next 5 years ($25 to $55). then they don’t discount back at 17%. JG: Well. And people might even tend to give out higher multiples though we wouldn’t.70. the basis of the exercise is you know how analysts just stick a multiple on it. Usually. They brought in the woman who now has been running Loft for the past five years and who has a great track record at that brand to run the ANN Taylor brand. So you are at $55 on a $25 stock in four years.50 in cash. they would generate another $7 in cash over that 5 year period and that gets you to $10. footage growth per year.00 so you get to $3. you say this concept has 340 stores and they can go to 680. You have to do what you think is reasonable. what will they earn? How long will it take them to build out to 680 stores? What net cash build will they have in the interim? Then you can put a slower growth multiple at the end. They currently have cash of $3. So with the current store base the EPS is $1. If they get back to 12% margins—it is not that they probably won’t pay more for this— just because that is the way they analyze this. JG: And if you remember our discussion last week. they discount back at 10% or 8% and you will get back a lot of that income upfront. It is really better to say. In retail if you sort of know the end game—not that they couldn’t come up with new concepts—with the concept they have. Well that 17% annualized growth assuming they figure it out in two years. maybe they will come up with a new concept and we get a freebie—may be they won’t. You get to about a $60 stock price. So it is possible to make 50% to 70% on this name in the next year if this plays out. You can take a conservative number and you can put a 12x at the end of four years. If they have 12% margins. But you pick a reasonable multiple and discount back rather than try to guess at a multiple. I think Linda came up with a $60 stock. then with the additional build out in the 12% range adds $2. Well it is growing at x percent so therefore it deserves this multiple.csinvesting. this is what they will earn at the end of that.
We used to own 10% of Chico’s about 8 years ago.Lecture 9: A Value Investor in Retail Discusses ANN to build inventories to 20% to 25% a sq.wordpress. If I had hung on to Chico’s……. Not only did the merchandise not sell but it was acerbated because the manager brought in way too much of it (overstocked on poorly selling inventory!). I don’t know how many times the stock has split since we owned it at $4. We sent people out across the country to go to different malls. The loyalty of the customers was what really came though. So we will watch inventories go down. And the beauty of it is that their customers keep coming back and keep waiting for them to get it right because they have nowhere else to go really other than Department stores and people for the most part are not in love with department stores and department store shopping. That is a big red flag when you see inventories go up particularly in the face in declining sales. The bigger question is whether they can get the merchandise right.. Professor: By the way. The one thing we were holding this thing for was that when you talked to their customers they were the most loyal people—things at the stores were horrible—they kept coming back hoping it would change. So certainly you can certainly take the bet that they will manage their inventories better. You can also look at the competitive landscape—Although I mentioned Banana Republic and Talbot’s--the nice thing about ANN is that there is no one else doing exactly what they are doing in the specialty store format. This company has one of the most loyal customer bases of any concept. They finally got it right. foot. that might take longer. We lived through a few seasons. We have done research on ANN Taylor Stores (ANN) by going out to the malls and have spoken to their customers. What you will find out is that what they are doing in NY may not be what they are doing in the Midwest. But I am willing to make the bet with somebody who has the kind of experience that this woman has who is running Loft that they will regain their footing. then there is huge operating leverage. If they do get it right. The nice part about that was management took a step back and now they have put in a much more disciplined planning and allocation process. so ANN sort of has a really nice niche. so we took a big bet on a retailer. ANN has a lot of leeway in terms of having the time and ability to get it right because these customers will keep coming back. but their customers love the store. Professor: How did you do that? How did you interview customers? LG: We spoke to those who had ANN Taylor bags and who didn’t. There is nobody else who caters exactly to these kinds of customers.com studying/teaching/investing Page 16 . Merchandising and inventory issues going on. www. they brought in the original people who had started the chain and they turned the thing around. It is the type of thing that can happen here. younger customer.csinvesting. We got out at even as opposed to making 28 times our money. So if you have loyal customers like ANN and they have their own niche like Chico’s. Banana is more fashioned forward. so we have owned it at the equivalent of a $1 and now it is at $28. Talbot is a much more conservative customer. I was young and stupid. GI: I walk in and think that this stuff is ugly. There are twofold ways to win: improvement on their inventory issues and their customer base (will give them time and ability to improve their situation). We spoke also to people who walked into stores and who did not buy anything.
Going back to the cannibalization question about this company.50. And I look at where they are today.wordpress.50 in cash for approximately $19. They had one type of sweater in 20 different colors. So I look out a year or two and I say and if they are not doing great things with the business but Loft continues to hold its own.60 to 1.5 per share in cash so if they can continue to grow the store base. How do you get to that $21 number? GI: I have to believe things will get a little bit better than they did this year (2004). That is an easy number to figure out because they will tell you and you can do the math. And certainly with their inventory problem I am confident that they will not make the same mistakes there. how big the stores are. They have had a revolving door of merchandising managers. then this at least deserves at least a 10 multiple so they have $3. The sky is the limit when people are excited about retail stocks.50 to $20.70 range. and I put a conservative multiple on it. Student: You think that there is limited downside to $21. If they continue to do not such a great job. where is my downside? Where can it trade? It could trade down to $20. Student: How so you talk to customers? LG: I send people out to talk to customers. What is nice about this is that there have been takeover rumors so that has held up the bottom for the stock. but it may take a while for things to play out for the short. Student: how did you get to 13% to 15% growth in stores? LG: That is what the company told me.Lecture 9: A Value Investor in Retail Discusses ANN Student: How bad did they get it in their merchandising? GI: They were over assorted. Meanwhile the company is trading at 40 times. how many more they can open. People are happy to talk. They had a pink pair of pants together with a pink sweater. It has to be a fundamental issue with the company. They were poorly merchandise on the floor. But people are happy to talk about their shopping experience.csinvesting. footage will be on top of what they have now. She will do as much as she can to differentiate the two chains to make sure they are dealing with separate customer bases. even if they don’t even do it well. If there is anybody who knows who this company is trying to cater to for each of their concepts it is this woman. Student: Do you short? GI: I don’t short based on valuation. they can still earn $1. www. This company has been able to generate the kinds of returns that they have because nobody else was doing what they were doing. Like a fundamental shift in the competitive landscape. especially loyal customers. We have people who take surveys—what do people like and don’t like.com studying/teaching/investing Page 17 . Put a 10 multiple on that for $16 or $17 and add in the $3. multiply that and I know how many stores they will open. So I can calculate how much growth the new amount of sq. but then all of a sudden new competitors start coming into their niche.
(ANN has a unique. They have floundered on the casual side. There is an opportunity there.Lecture 9: A Value Investor in Retail Discusses ANN Student: Look out how many stores they can open and assume some time scale for when they open those stores. more fashion forward merchandise. END www. There is not much serving the middle of the road customers.csinvesting. and it does not offer a lot of wear to work clothes.com studying/teaching/investing Page 18 . What is the niche? LG: It is women’s wear for predominantly 35 to 55 year old women who are not super fashion forward. Talbot’s has a much more conservative customer. underserved niche). Then back out the rate.wordpress. Pant suits. A lot of it is wear to work fashion but it is not super conservative. Banana offers a couple of suits but its customers are more interested in trendier.
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