Today we preview the Annomaly that is Ann Taylor (NYSE:ANN), whose stock has risen 44% in the past 52 weeks on steadily growing sales. Despite those skyrocketing sales, with every quarter it appears to earn fewer and fewer pennies on each dollar's worth of merchandise sold. The company is set to report Q4 and full-year 2005 earnings tomorrow.

Wall Street Wisdom:

  • General consensus. Twenty analysts track Ann. Nine of them rate the stock a buy, nine more a hold, and the last two a sell.
  • Revenues. Analysts predict that Ann will report a 17% rise in quarterly sales versus Q4 2004, for a total of $569 million. For the record, Ann already reported beating that estimate back in February, when it announced 18% sales growth to $574 million.
  • Earnings. Ann's expected to report a reversal of last year's money-losing Q4, returning to profitability with $0.44 per share. What's the likelihood of that happening? Pretty good, I'd say. Ann hasn't "missed" analyst estimates once in this millennium.

Margin watch:
So everything's hunky-dory, right? Maybe yes, maybe no. Look at the chart below, and watch in horror as Ann's margins unravel over the 18 months reflected.

Margins %

7/04

10/04

1/05

4/05

7/05

10/05

Gross

55.8

54.2

51.1

49.4

48.1

49

Op.

11.9

10

5.7

4.2

2.5

3.3

Net

7.1

5.9

3

2.6

1.3

2.1
All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ending in the named months.

Foolish forensics:
So far this year, Ann's sales have grown a healthy 10% year over year. However, the cost of goods sold outpaced that rate at 17%, resulting in operating earnings that fell 31% short of last year's numbers, despite higher sales. Divide smaller profits by larger sales, and you get contracting margins.

The good news: That's all under GAAP accounting. On a cash profits basis, Ann is looking healthier than it did a year ago. The company generated $16 million in free cash flow in the first three quarters of 2005, versus negative $50 million in free cash flow by the end of Q3 2004. Inventories declined, and the company's press releases, which address inventory levels every month, demonstrate that Ann is keeping close watch over this issue.

In my opinion, Ann is beginning to regain its footing. If it can keep the inventories under control and the cash flowing in, sooner or later those accomplishments will produce GAAP margin improvement. The booming stock price suggests that Mr. Market is expecting much the same outcome.

Fool contributor Rich Smith does not own shares of Ann Taylor.