Throw This Stock Away

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Let's go shopping this week.

Several out-of-favor retailers have delivered scorching returns in recent months, even while many of the mall chains are still sputtering. Chasing some of these stocks before the fundamentals catch up can be as ghastly a mistake as matching plaid pants with a polkadot shirt.

I'm no Grinch, though. I don't rip into a stock unless I have three perfectly capable replacements for your portfolio.

What gets tossed out this week? Come on down, Ann Taylor (NYSE: ANN).

Don't go out there looking like that
Few stocks that have enjoyed the past few months of rallying markets as much as Ann Taylor has. Since bottoming out at $2.41 in March, the stock has headed 384% higher.

Now, there are plenty of good reasons for a retailer's stock to go on a mad tear like that. Sadly, Ann Taylor doesn't have any of them.

• Earnings growing nicely? Nope. The company posted a loss in its fiscal first quarter, and analysts see a loss of $0.35 a share for all of fiscal 2009.
• Customers storming back? Wrong again. Comps fell by a brutal 30.7% during its most recent quarter, with its namesake stores suffering a horrendous 43% slide. A 24% decline in same-store sales at its Ann Taylor LOFT stores is only relatively better, but still horrible.
• Wall Street underestimating its potential? Not quite. The apparel specialist has missed analyst estimates in two of the past three quarters.
• The concept in the right place at the right time? No way. The 320 Ann Taylor stores -- and to a lesser extent its 510 LOFT locations -- stock classic clothing for career-minded women. In a soft economy, unemployed professionals don't need to replenish a closet full of work clothes.

Even after its disastrous fiscal first quarter, Ann Taylor was patting its own back. The retailer was bragging about posting a dramatic improvement in gross margins, even though it ultimately reversed a year-ago profit with a small deficit. Isn't the bottom line what ultimately counts? This is like bragging about selling a single $10 cup of lemonade. The markup may be sweet, but there's still the lemonade stand and hired stirrers who beg for a model built around volume.

Ann Taylor realizes that it needs a spark. The crummy comps are crying for change. In response, the company will update its wares in an autumn remodeling of its flagship concept. But how many makeovers has Gap's (NYSE: GPS) Old Navy gone through to little avail?

Ann Taylor isn't a complete wreck. Its balance sheet is respectable in an industry that's typically overleveraged, and it has been effectively whacking away at its cost structure. Analysts see this year's loss evolving into a profit of $0.19 a share next year.

Despite these improvements, I would still wait. The stock has run up too high, and the signs of an operational turnaround are just not there. Ann Taylor reports its quarterly results on Friday, and it's going to take a lot of good news to justify today's double-digit price tag. 

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.

• Buckle (NYSE: BKE): You will never confuse an Ann Taylor shopper with a Buckle patron. Vintage denim and burnout tops at Buckle cater to a younger, more casual audience. However, Buckle has been able to grow through most of this recession and post positive comps along the way. Analysts see revenue climbing by 14% this year, with earnings growing even faster at a 19% clip. Buckle's a bargain at less than 11 times this year's projected profitability.
• Dress Barn (Nasdaq: DBRN): While it downgraded bebe stores (Nasdaq: BEBE) last week, Raymond James was busy upgrading shares of Dress Barn. The analyst suggested that value-conscious chains including Dress Barn are gaining market share, at the expense of pricier trendsetters such as bebe. I'm also a fan of Dress Barn's summertime deal to acquire Tween Brands (NYSE: TWB), in a bold push to reach out to younger shoppers at a time when most mall chains are in retreat.
• Amazon.com (Nasdaq: AMZN): If the ambitious launch of Endless.com a couple of years ago didn't convince you that Amazon wanted more skin in the fashion game, the recent announced purchase of online footwear speedster Zappos should. The leading online retailer is making the most of its girth, by growing at a time when most concepts are going in reverse. Its "Amazon Prime" membership program is making the site a one-stop shop for everything from software to bulk groceries to cardigans. The stock isn't cheap on an earnings basis, but it's generating twice as much free cash flow as it is reported profitability. Don't be surprised if the next blouse or pantsuit that you would normally buy at LOFT winds up coming from Amazon.com

Shop carefully.

Do you like Rick's substitutions? Would you rather stick it out with the tossed company? Are there other stocks Rick should look at in future editions of this column? Let him have it in the comment box below.