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Friday, May 14, 1999

An Investment Opinion
by Warren Gump

Waiting for the Perfect Pitch

One of the nicest features of our stock market is that no one has to buy any specific stock. If you're uncomfortable for any reason, you can just say no. As Warren Buffett says, there are no "called strikes." You can continually have wonderful companies thrown across your investment plate, but you'll never be called out for not swinging. What freedom and flexibility. You only need to take action if you're totally comfortable with the company being pitched your way. Today, I'm going to talk about a phenomenal company that once again posted spectacular results earlier this week. Nonetheless, I'm going to pass on the investment opportunity.

Abercrombie & Fitch (NYSE: ANF) is one of the more successful retailers of the past few years. Once a subsidiary of the Limited (NYSE: LTD), a sliver in the company was sold to the public in 1996. Since that time, the stock has surged from $16 to $86 at its close today. The Limited divested its remaining stake in the company in May 1998.

Abercrombie & Fitch has struck a chord with today's clothes buyer. Same-store sales, a basic measure of a retailer's health, have been strong for years. While most companies post increases in the low-mid single digits, Abercrombie & Fitch has seen comparable sales rise up to 48%. Starting with the last quarter of fiscal 1998 (which is basically calendar 1997), quarterly same-store sales have increased 23%, 48%, 45%, 35%, 26%, and 22%, respectively. The slowdown over the past several quarters is normal since sales were so strong in the prior year period. When a store had sales increase 48% the prior year, it is very tough to continue to grow sales at a rapid pace. Being able to grow sales 22% over such tough comparisons is truly amazing.

Part of the success at Abercrombie & Fitch has been its creation of a lifestyle brand. Through marketing, store environment, a "magalog" -- a combination magazine/catalog, and product design, the brand embodies characteristics that many people strive to achieve. Further expanding its reach, the company plans to begin selling products over the Internet later this year. Management warned that it doesn't expect this initiative to have a significant impact on results in the near-term.

The company's financial results have reflected the company's success. From fiscal 1998 to fiscal 1999, earnings per share (EPS) grew 104%. That's on top of the 96% increase the prior year. Analysts currently estimate that the company will earn $2.51 a share this year, growth of another 31%. If Q1 results are any indicator, that number could be conservative. The company reported EPS of $0.23, 92% above last year and $0.06 ahead of estimates.

Beyond the core 186-store Abercrombie & Fitch unit, the company is accelerating the introduction of the 14-unit Abercrombie division, which caters to 7-14 year-olds. Plans call for the opening of 36 new Abercrombie & Fitch stores and 20 Abercrombie stores this year. With a cash horde of $135 million and no long term debt, the company shouldn't have any problems financing these plans.

Given all of this good news, why am I not investing in Abercrombie & Fitch? It's quite simple. Over the past year, I've found less and less that appeals to me in their stores. Two or three years ago, I would walk into an Abercrombie & Fitch store and like almost everything. Now, I go in and I am bewildered. Last weekend, wandering along the streets of Georgetown, I stepped into one of the local Abercrombie & Fitch stores. I only saw one thing I liked -- a $34 T-shirt. Is this the store that once supplied almost half my wardrobe? Same name, different store.

Whereas visiting an Abercrombie & Fitch store used to comfort me, I now get a little queasy. Where have the great basics gone? I want simple chinos and shorts, not 14-pocket cargo pants and Hawaiian hats. I prefer things that never really go out of style. With an increasing emphasis on fashion-oriented clothes, I fear the company will be more significantly subject to shifting styles than it has been in the past. Despite being run by a management team that has proven miraculously adept at tracking fashion trends, I don't want to be near the stock if an unexpected transformation in fashion occurs.

From an overall analytical perspective, everything looks excellent at Abercrombie & Fitch. The company has plenty of room to grow, is enjoying superb profitability, and has a terrific management team. If there were "called strikes" in investing, I'd have to swing since this is right down the middle. Fortunately, that's not the case. I can continue standing in the batter's box with bat rested on shoulder. While Abercrombie & Fitch might be ideal for many investors, it just isn't right for me. Next pitch.

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