Ascena Retail Group Inc.
Nasdaq: ASNA
Closing Share Price on 5/27/2016: $7.14

Ascena Retail Group is a conglomeration of eight retail clothing and accessory brands operating retail stores and e-commerce platforms. The company’s stock currently trades at a very low valuation after having dropped roughly 60% from its 52-week high.

The recent weakness in ASNA seems to stem from its corporate strategy (highly M&A focused) as well as a general distaste by investors for any apparel-focused, bricks and mortar reliant retailer. The conventional wisdom on Wall Street right now is that consumer spending is tepid, despite low gas prices, due largely to modest wage growth. Accordingly, the thinking goes that when people are spending they are using their discretionary income on categories such as home improvement and furnishings, travel, live entertainment, consumer electronics, and dining out. Given how basic needs such as clothing are not going away, coupled with the fact that they do in fact wear out after prolonged usage, it does not seem likely that consumers are going to stop buying clothes. If one accepts this thesis, there are likely many attractive investment opportunities in the apparel and accessories space.

ASNA stands out due to a deep selection of brands that cover a wide base of women’s apparel. Founded as Dress Barn by the Jaffe family in 1962, the company has diversified over the years by acquiring other brands; Maurice’s in 2005, Justice in 2009, Charming Shoppes in 2012, and most recently Ann Inc. in 2015. With a background in the private equity industry, current CEO David Jaffe has built a leading women’s apparel and accessories company with an eye on shareholder value.

To give you a sense of how far the company’s stock has come down, ASNA acquired Ann Inc (Ann Taylor and LOFT brands) in 2015 for more than $2 billion (~$1.7 billion in cash and ~$350 million in ASNA stock). Since the deal was announced in May 2015, ASNA shares have lost half of their value and the equity market value of the entire company currently stands at less than $1.4 billion. Factoring in debt outstanding, the legacy ASNA business is now being valued by investors at just $800 million. That compares to $2.3 billion the day before the Ann Inc. acquisition was announced.

Given how strong of a business Ann Inc. has proven to be (one of most consistently profitable performers in the industry prior to the buyout), coupled with Ascena’s broad experience successfully integrating new brands on their platform, the equity market appears to be heavily discounting the viability of this company.

The management team at ASNA has laid out impressive EBITDA goals for both 2016 ($685 million) and 2018 post-integration ($1 billion). Compared to the company’s current enterprise value of $2.8 billion ($1.4 billion of both equity and net debt), the stock trades at one of the lowest valuations in the sector.

In addition to profitability goals, ASNA also recently announced a $200 million share repurchase authorization as well as a desire to delever their balance sheet (loans were used to fund most of the Ann Inc deal) by using at least 50% of free cash flow to pay down debt. The company’s current leverage ratio stands at only around 2.0x but that could easily move towards 1.0x by the end of 2018 thanks to EBITDA expansion and debt repayment.

To get a sense of how much upside could be possible if management delivers on its goal of $1 billion of EBITDA in 2018, consider that even a modest EV/EBITDA multiple of 5.0x (retailers typically fetch 6-8x in the public markets) would result in huge upside. If one assumes $1.3 billion of net debt in 2018, ASNA would garner an equity value of $3.7 billion. Assuming no stock buybacks over the next two years, ASNA’s share price would surpass $19 per share.

Now let’s consider the downside. If management can only get 2018 EBITDA up to $800 million (20% short of their goal), the stock price would still double to $14 per share. Frankly, the risk-reward situation in this stock appears to be sharply unbalanced.

Ascena Retail Group Inc. Stock Price Sensitivity Analysis: