Veteran Wall Streeters know that when it comes to investing, past performance holds no guarantees for the future. That said, those contemplating buying shares of a streaky retail chain like Ann Taylor ( ANN) would do well to consider a little history. Over the course of the last year, new Chief Executive Kay Krill has rescued Ann Taylor from a debilitating fashion whiff and transformed it back into one of the hottest clothing destinations for women. While a number of other specialty chains, like Gap ( GPS) and Limited Brands ( LTD), struggle to fix their own merchandise problems, Krill's performance has won plaudits on Wall Street and shares of Ann Taylor are reaching all-time highs. Now, the question is whether investors who missed the company's turnaround should buy the stock while Ann Taylor is at the top of its game. At current levels, the shares look priced for perfection. And, while the company will probably continue to perform well in the near future, it has a long history of ups and downs. While the stock market tanked on interest-rate worries this spring, Ann Taylor could do no wrong. Its shares climbed as the retailer extended its streak of positive same-store sales gains to eight months straight. On Wednesday, it closed up 59 cents, or 1.4%, to $43.66, after reaching a new high of $43.88 in intraday trading. The stock is up 90% from October, which is when Krill, a company veteran, took the helm. At the time, Ann Taylor was suffering from a long string of monthly comps declines as shoppers reacted coolly to its fashions. As a merchandise guru who had been president of all three of the company's divisions, Krill was able to erase past mistakes by offering customers the types of clothes they were previously accustomed to finding at the stores.
Ann Taylor had lost track of that classic style that they once stood for and took a little too many chances when it came to color and silhouettes," says Dan Hess, chief executive of research firm Merchant Forecast LLC. "Now they've gone to a much more saleable or neutral color palette and much more wearable fashion." Hess says Krill also managed to draw a more effective division between Ann Taylor's flagship stores and its popular Ann Taylor Loft division, which sells more casual women's fashions at a lower price point. In the past, the two chains have been known to cannibalize each other's business Ann Taylor did not return requests for an interview for this story. Aside from merchandising, the company has improved its operations and profitability. In the first quarter, Ann Taylor's net income rose to $39 million from $17 million a year earlier. Its total sales rose 17% to $556.2 million on a 7.4% jump in same-store sales at the Ann Taylor division and a 4.7% gain at Loft. Inventory levels declined by 19%. The company's operating margin jumped to 11.4% for the quarter from last year's 5.8%. While that marks a dramatic improvement, it still lags behind best-in-breed specialty chains like American Eagle Outfitters ( AEOS), which boasted a first-quarter operating margin of 18.9%. So there's still room for improvement, but dramatic gains for the rest of this year are already being predicted in today's stock price. If analysts assign the historically generous price-to-earnings multiple of 20 to Ann Taylor, then its current share price means investors are expecting 2006 earnings of $2.18 a share -- or a whopping 98% increase. Analysts on Wall Street are forecasting earnings for the year of $1.88, which means that investors bidding up the stock at these levels are either chasing a momentum play or betting on a massive upside surprise.
"This is not for the fainthearted at these levels," says Howard Davidowitz, chairman of Davidowitz & Associates, a retail consulting and investment banking firm in New York. "What you've got built into the stock price here is two more years of great performance. They're in a very crowded field, competing against tough people, and this is a company that has had tremendous ups and downs over the course of the last decade." Along with valuation worries, the recent and sudden departures of key operational people like Chief Operating Officer Laura Weil and Chief Marketing Officer Muriel Gonzalez have some shareholders wondering if the dissension in the ranks that has plagued Ann Taylor has truly gone away. Market sources requesting anonymity say that Weil left after a dispute with Krill. Weil was with the company for only eight months, having been brought onboard last fall from American Eagle Outfitters to serve as the operational ying to Krill's merchandising yang. In the absence of Weil, most of the operational talents that remain are longtime veterans of Ann Taylor with a checkered track record of boosting profitability. Also, the company's limited growth prospects are hardly deserving of a rich valuation. At the end of the first quarter, Ann Taylor recorded a total store count of 824, consisting of 352 Ann Taylor stores, 421 Loft stores and 51 Ann Taylor Factory stores. That figure reflects no overall growth in store count for the quarter, and analysts are skeptical about whether the company's current stable of concepts has much organic growth left. Krill is expected to present a new concept to the board in November. Later this year, Ann Taylor will start to face harder comparisons for its monthly comps, and observers say the true test of the current stock price is set to come in 2007. Without Weil around to call the operational shots for next year's strategy, the hurdles could get even higher. Also, if gas prices stay steep and interest rates keep climbing, retailers could be coping with a much different economic situation by then. "Kay Krill did great things for this business, and all I can do is applaud her, but Mickey Drexler did a great job as a merchandiser at Gap and that didn't last forever," says Davidowitz. "Investors need to remember that the way it works in retail is that every season the curtain goes up and it's a new ballgame, and Ann Taylor has never managed to string together two years in a row with this kind of performance."