A report from Janney Capital Markets published on Wednesday, July 9th suggests that the softlines sector is near a bottom in terms of stock performance and negative earnings revisions. Janney analysts Adrienne Tennant and Gabriella Carbone suggest that the softline retailers sector is an attractive investment alternative both because of improving fundamentals and the increasing of M&A activity, especially leveraged buyouts.
Tenannt and Carbone summarize their current point of view on softline retailers in the introduction of their report. “We are increasingly sanguine about 2H14 prospects as we note: 1) a Gross Margin Return on Inventory Investment (“GMROI”) trough in 4Q13, 2) sequential improvement (albeit still flat-to-slightly deeper thus far in 2Q14) in year-over-year promotional cadence, 3) sequential improvement in the sales-to-inventory dollar growth spread, and 4) a pickup in private equity and activist investor activity/stakes in Softline retailers.”
LBO likelihood modeling
The bulk of the Janney report is spent on LBO modeling of a number of retailers for which “attractive private equity returns are achievable.” Tennant and Carbone highlight that private equity deals in this space have historically been priced “between 8.0x and 10.0x trailing twelve month (“TTM”) EV/EBITDA multiples, while strategic deals have been priced in the 10.5x to 14.5x TTM EV/EBITDA multiple range.”
The analysts screened companies in the Softlines sector for LBO opportunities using the following screening criteria: “1) FY15 valuation of approximately 0.7x EV/Sales or less and/or approximately 6.0x EV/EBITDA or less, 2) net cash position on the balance sheet as of the most recent quarter, 3) profitability, 4) positive free cash flow, and 5) brand equity that still resonates with consumers.”
Softline retailers that came up after screening for these criteria include: Abercrombie & Fitch Co. (NYSE:ANF), American Eagle Outfitters (NYSE:AEO), Ann Inc (NYSE:ANN), Chico’s FAS, Inc. (NYSE:CHS), Express, Inc. (NYSE:EXPR) and Childrens Place Inc (NASDAQ:PLCE). The report also included an LBO scenario for Lululemon Athletica inc. (NASDAQ:LULU) (TSE:LLL) given founder Chip Wilson has hired an adviser to explore strategic alternatives likely to include a possible management buyout.
The LBO scenario models created by the analysts suggest premiums ranging from 15% to 35% are possible in the screened stocks in the event of an LBO.
Buy-rated softline retailers
Among the softline retailers that came up in Tennant and Carbone’s LBO likelihood screening are Abercrombie & Fitch Co. (NYSE:ANF), Ann Inc (NYSE:ANN) and Express, Inc. (NYSE:EXPR), which are all currently rated as a Buy by Janney.
