Is Ascena Retail Group a Timely Investment?

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In this post-recessionary economy, consumers have been forced to control discretionary spending. Among consumer discretionary stocks, many retailers have been laggards in terms of their performance. Specialty retailers such as Ascena Retail Group (NAS: ASNA) , as well as Aeropostale (NYS: ARO) , American Eagle Outfitters (NYS: AEO) , Chico's (NYS: CHS) , and Fossil (NAS: FOSL) , have consequently exhibited poor earnings quality over the past several quarters. While there are many specialty retailers for consideration, I chose these because they are listed in the S&P 400 mid-cap index.

Earnings quality is reflected in the financial statements
The Motley Fool offers two databases -- EQ Scan and EQ Score -- that are used to uncover cash flow and revenue recognition issues. Smart financial officers can use several techniques to manipulate financial results, and manipulation of any of the three financial statements usually affects the other two. But a critical eye on these statements can often uncover trends that could be important for investors to understand before hard-earned money has been lost.

The EQ Score database assigns an index rank to the company from 1 (lowest quality) to 5 (highest quality). As the company's financial status changes over time, the database adjusts its rank and illuminates trends that will affect earnings quality going forward.

How are specialty retailers trending?

Retailer

EQ 
Score, 
January 
2012

EQ 
Score, 
February 
2012

EQ 
Score, 
March 
2012

Trend

Likely 
Issue

Ascena Retail Group113UpCash Flow
ANN342DownRevenue
AeropostaleNot RankedNot RankedNot RankedFlatRevenue
American Eagle Outfitters231DownRevenue
Chico's441DownCash Flow
Foot LockerNot RankedNot RankedNot RankedFlatRevenue
Fossil111FlatCash Flow
SaksNot RankedNot RankedNot RankedFlatCash Flow

Source: Fool EQ Score, for the week ending 3/9/12.

As a group, specialty retailers on average have been flat overall, with three trending up, three trending down, and the remaining four showing no trend. The more important question is why.

Ascena, Chico's, Fossil, and Saks all exhibit cash-flow issues. I'll discuss Chico's, Fossil, and Saks further in future commentaries, but let's take a brief look. Chico's year-over-year working capital has decreased 50% on average the past two quarters; its cash conversion cycle (a measure of time to convert sales to cash and back into products) jumped from 23 days to 32 days, or 40%; and free cash flow has been significantly negative the past four quarters. Because factors such as seasonality affect some retailers more than others, we'll also consider this in our analysis.

Fossil is one such retailer whose cash flow is affected by seasonality: FCF is down 48% year over year and has been negative the past three quarters. Days in inventory has grown 31%, and its cash conversion cycle has increased 6% year over year.

Seasonality also affects Saks, a high-end specialty retailer. Revenue grew slightly year over year (7%), but inventory levels increased 8%. Saks' days in inventory is unacceptably high at 114 days, and its cash conversion cycle is 126 days.

Ascena is a leader among S&P 400 specialty retailer stocks
Ascena operates as a specialty retailer of apparel, accessories, footwear, intimates, and lifestyle products for women and tween (i.e., preadolescent) girls in the United States, Puerto Rico, and Canada. The company operates its stores under the Dress Barn, maurices, and Justice brand names. The company, formerly known as Dress Barn, changed its name in January 2011. It was founded in 1962 and is based in Suffern, N.Y.

Ascena's Achilles' heel: cash management
Cash management had been holding this stock's score down, but an improvement on that front has breathed new life into Ascena. Year-over-year income-statement metrics have been outstanding on average since 2010, with revenue, gross profit, operating income, net income, and EPS all nicely positive year over year. Balance-sheet metrics are similarly appealing: The company has virtually no accounts receivable or days sales outstanding, because it moves inventory from its own stores and not through other retailers, such as Wal-Mart. One knock is that inventory has grown slightly, and days in inventory has increased from 105 days to 139 days on average. Overall, cash-flow metrics look to be improving. Finally, the company carries no long-term debt.

On March 1, Ascena reported second-quarter revenue of $862.0 million, versus a consensus of $829.9 million, and raised guidance to $2.75-$2.80 from $2.60-$2.70 per share for fiscal 2012, versus a consensus of $2.66. The company plans to open approximately 145 stores and close around 55 in fiscal 2012, ending the year with approximately 2,600 stores in operation.

On March 8, the company announced a 2-for-1 stock split: Shares most recently traded at $44, and the stock has been trending upwards since its low of $25.39 last Nov. 25. The stock has a trailing P/E of 18.37 and a forward P/E of 13.97, well within its demonstrated growth rate.

Retail stocks are getting a lot of attention recently. The jump in February retail sales is an encouraging sign for many big domestic names. Here at the Fool, though, we think the biggest growth will come from outside our borders. We've identified one such stock that we like so much we named it The Motley Fool's Top Stock for 2012. You can uncover this top pick today.

At the time this article was published Fool contributorJohn Del Vecchiois co-advisor to Motley Fool Alpha and co-manager of the Active Bear ETF. You may follow him on Twitter, where he goes by @johnfdelvecchio. He owns no shares in the companies mentioned in this article. The Motley Fool owns shares of Fossil, Wal-Mart Stores, and Aeropostale.Motley Fool newsletter serviceshave recommended buying shares of Wal-Mart Stores and Fossil, creating a diagonal call position in Wal-Mart Stores, and shorting Fossil. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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