Abercrombie a C-K?
Let's take a look
by Tom Gardner ([email protected])

ALEXANDRIA, VA (Oct. 30, 1998) -- Do you wear oversized flannel shirts? Does your niece bounce around the neighborhood in wide-cut skateboarder pants? Was your husband seen wearing polka-dot boxers? Is that your grandfather on the dock wearing an "AF" baseball cap?

If so, you may be looking at Abercrombie & Fitch (NYSE: ANF) clothing. The company, spun off from The Limited in an IPO in 1996, has been going like gangbusters ever since. Socks, boxers, flannels, T-shirts, jackets, you name it, Abercrombie has privately-labeled it and is selling it through mall storefronts across the country. Abercrombie & Fitch has the feel of a consumer brand featuring habitual buying across a mass market.

Now, if you've read some of my recent Cash-King columns, from Playboy to Nine West, to Amazon.com, you probably feel like you're being set up. In those reviews, I praised elements of each business model, only later to kick them out of Cash-King consideration. Playboy has forced limits on its customer base; Nine West was failing miserably at managing its inventory; and Amazon.com was just too young to warrant our attention in this portfolio of dynasties.

So, you're probably peering into your monitor now under skeptical brows. Perhaps you're thinking: "Yes, Abercrombie may have a national presence. Yes, they may be a company that I know. Yes, they may be extending their business at a furious pace. Yes, my daughter does shade her eyes from me with the lid of an AF ballcap. But, no, absolutely not. I will not believe this is a Cash-King company until I see all the numbers. I will not be persuaded by, say, rising gross margins because I know that they could travel in step with mountains of debt or poor product management. Fool, I need all the numbers, first -- from both the income statement and the balance sheet."

Wow, you had a lot to say tonight.

Well, good evening to you. I hope you're preparing for a wonderful Halloween tomorrow night. And I'd like to spend the next fifteen minutes with you, casting our eyes on a few photographs of Abercrombie & Fitch's business. Now, ANF truly has been expanding at breakneck speed, as you'll see in the sales figures below. But, full disclosure, the stock has done no better nor worse than the S&P 500 since its public offering back in September 1996. Either the market is rightly indifferent to this business, or investors are mistaking greatness for mediocrity.

Let's take a look at the retailer's most recent quarter, the second quarter of its fiscal 1999. Here are the figures from their income statement: 

                2Q 1999      2Q 1998 
 Sales           $147 mil.    $87 mil 
 Gross Margins     37.5%       32.1% 
 Net Income       $11 mil.    $2 mil. 
 Net Margins        7.2%        2.4%

The comparison shows 69% sales growth over the same quarter last year. Indeed, Abercrombie is on a selling rampage. But, impressively, the company is being doubly propelled by a simultaneous gain in its rate of profitability. Gross margins are up 5.4 percentage points. Net margins are up 4.8 percentage points. The flannel stitcher is playing the two most powerful cards in all of business: 1) rising sales and 2) increasing profitability.

That's like putting Skippy on your peanut-butter cookie. It's like ice sailing on a downward slope with a jet engine strapped to the stern. It's like a candy corn inside of a candy corn. It's like health and happiness and freedom, altogether. But we've seen it before, haven't we? Or something like it. Nine West Group certainly grew sales while inching its rate of profitability higher. It featured both. But then what happened? The shoe-seller's Flow Ratio winged out of control, rising above 3.0, and with time, Nine West's stock stumbled and crumbled.

Is that the case for Abercrombie? Let's look at the balance sheet: 

              2Q 1999     2Q 1998 
 Cash          $46 mil.    $43 mil. 
 Debt          $0          $50 mil. 
 Flow Ratio     0.91        0.99

What do you think, Fool? Cash is up $3 million. The $50 million in long-term debt was paid down in full. And the company's Flow Ratio has fallen from 0.99 to 0.91, or 10%. That makes the underlying business look pretty darned sturdy. More cash, goodbye to the debt, and tighter financial controls. I grade the balance sheet a solid A.

And when you couple it back with the selling performance on the income statement, you have to be pretty impressed. During a period that Abercrombie & Fitch grew sales by 69% and earnings by 450%, it also firmed up foundations for the future. To quote a kindred spirit, Chauncey Gardner, "Today, the soil is healthier though the farmer planted aggressively." Abercrombie & Fitch's prospects just look superb, today.

But ah, what better way to close tonight's report, and to head into the spooking season, than to turn to the Wise for their opinion. First, BancBoston Robertson Stephens. The firm reiterated its Strong Buy on Abercrombie and raised quarterly estimates by three cents. I don't pretend to have estimates for the upcoming three-month period in mind, but our structural analysis of the retailer's business has me agreeing with Robertson Stephens' enthusiasm.

And now, one more time with the Wise before going. In digging through information on the company, I found that all the way back on October 24, 1997 Merrill Lynch announced that it was upgrading Abercrombie & Fitch from an "Accumulate" to a "Near-Term Buy" rating (guffaw!). Then just a month later, on November 21, Merrill downgraded it from "Buy" to "Near-Term Accumulate." Interesting. They changed their mind in a month.

I wonder why.

Well, I hope the firm generated some nice commissions on those recommendations. Because when they downgraded the stock on October 24, it was at $24. And when they upgraded it on November 21, it was at $32. And that, dear Fool, is the end of my story on investing and Abercrombie & Fitch for the day. I am very impressed with this company and plan to study it in greater detail in the weeks ahead.

Fool on and Happy Halloween,

Tom Gardner

Cash-King Strategy Folder
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10/30/98 Close

Stock  Change    Bid 
 AXP   +2 13/32 88.09 
 CHV   +1 5/8   81.50 
 CSCO  +  5/16  63.00 
 KO    -  3/16  67.63 
 GPS   +1 1/8   60.13 
 EK    +1 9/16  77.50 
 XON   -1 1/16  71.63 
 GM    +1 7/8   63.06 
 INTC  -  9/16  89.19 
 MSFT  -  11/16 105.88 
 PFE   -  5/16  107.31 
 SGP   -  13/16 102.88 
 TROW  +3 9/16  35.56 
 
 
                  Day     Month   Year    History 
         C-K      +1.26%   5.56%  11.15%  11.15% 
         S&P:     +1.18%   8.03%   9.21%   9.21% 
         NASDAQ:  +0.81%   4.58%   6.30%   6.30% 
  
 Cash-King Stocks 
  
     Rec'd    #  Security     In At       Now    Change 
     2/3/98   24 Microsoft     78.27    105.88    35.27% 
     2/3/98   22 Pfizer        82.30    107.31    30.39% 
     5/1/98   37 Gap Inc.      51.09     60.13    17.68% 
    6/23/98   34 Cisco Syst    58.41     63.00     7.86% 
    8/21/98   22 Schering-P    95.99    102.88     7.18% 
     2/6/98   56 T. Rowe Pr    33.67     35.56     5.61% 
    2/13/98   22 Intel         84.67     89.19     5.33% 
    2/27/98   27 Coca-Cola     69.11     67.63    -2.14% 
    5/26/98   18 AmExpress    104.07     88.09   -15.35% 
  
 Foolish Four Stocks 
  
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko    63.15     77.50    22.73% 
    3/12/98   20 Exxon         64.34     71.63    11.33% 
    3/12/98   15 Chevron       83.34     81.50    -2.21% 
    3/12/98   17 General Mo    72.41     63.06   -12.90% 
  
 Cash-King Stocks 
  
     Rec'd    #  Security     In At     Value    Change 
     2/3/98   24 Microsoft   1878.45   2541.00   $662.55 
     2/3/98   22 Pfizer      1810.58   2360.88   $550.30 
     5/1/98   37 Gap Inc.    1890.33   2224.63   $334.30 
    6/23/98   34 Cisco Syst  1985.95   2142.00   $156.05 
    8/21/98   22 Schering-P   2111.7   2263.25   $151.55 
     2/6/98   56 T. Rowe Pr  1885.70   1991.50   $105.80 
    2/13/98   22 Intel       1862.83   1962.13    $99.30 
    2/27/98   27 Coca-Cola   1865.89   1825.88   -$40.02 
    5/26/98   18 AmExpress   1873.20   1585.69  -$287.51 
  
 Foolish Four Stocks 
  
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko  1262.95   1550.00   $287.05 
    3/12/98   20 Exxon       1286.70   1432.50   $145.80 
    3/12/98   15 Chevron     1250.14   1222.50   -$27.64 
    3/12/98   17 General Mo  1230.89   1072.06  -$158.83 
  
                               CASH    $120.62 
                              TOTAL  $24294.62 
  
   
 *Please note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.
  
   
 *The year for the S&P and Nasdaq is as of 02/03/98

</THE CASH-KING PORTFOLIO>

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