Abercrombie & Fitch (NYSE: ANF)
trading at $37.16 as of 10/26/04
There's nothing as scary as teenagers -- at least if we believe Grampa Simpson -- unless, of course, you're one of the many firms collecting all that disposable late-teen income. Then you probably find them a welcome sight. Let's face it, kids these days have a lot more money than back when mugs like you and me were wearing flour-sack shirts and patched-up dungarees.
Of course, the youth market still likes that worn-out look, preferring the 10-year-old polo shirt look to the gunnysack. But still, most young consumers don't have the time and energy to wear the stuff out themselves. That's where Abercrombie & Fitch comes in. As one of America's top brand names, Abercrombie is everywhere. Wrinkled-up cargo shorts, pre-destroyed pants. This stuff is still selling like crazy. Don't believe me? Check out the next high school football game in your neighborhood, or take a stroll at the nearest college campus. Count the A&F logos.
Scary stuff first
Sure, Abercrombie has engaged in some pretty ghoulish behavior from time to time. Thong underwear for tweeners? Incest T-shirts for the masses? Some of us Fools have wondered whether stunts like these couldn't come back to haunt the retailer. Could scandalized parents stop giving their kids money for Abercrombie?
Sure, Abercrombie's sales have been soft. They're up 15% for the year so far, coming to $1.2 billion bones. But comparable-store sales, a better measure of organic growth because it includes on establish stores, is down 2% for the same period. When the news came out a while back, the stock was taken to the woodshed. Meanwhile, competitors -- or copiers, some might argue -- such as Aeropostale (NYSE: ARO) and American Eagle Outfitters (Nasdaq: AEOS) have had amazing comps growth, even in the wake of the much ballyhooed retail slowdown this fall.
Still, I wouldn't bet that things will remain this way forever. Those others are still taking their cues from Abercrombie. And it looks likely to stay that way. How do you persuade legions of young consumers to shell out good money for fake old clothes sporting the A&F logo? Abercrombie's marketing remains top-notch, from the "magazine" that revolutionized the industry to the Web-borne cheesecake videos that feature scantily clad young men and women frolicking at sexually-charged, all-American, retro-preppy pastimes. Shirtless lacrosse and hot-pants powder-puff football are two recent examples.
Savor the sweetness
Of course, some of us cash-mongers have had our eyes on Abercrombie all this year. Up or down, the firm's strong cash position and enviable free cash flow make it look like an absolute bargain when compared with those who would aspire to its throne.
Even though the stock has appreciated quite a bit since I decided to present it as a Halloween treat (doh!), it still looks like a good value, especially given the strength of its brand. It trades for under 17 times earnings. Compare that to Aeropostale's 27 and American Eagle's 28. Judged on a "forward" P/E, based on estimates, the three are more closely aligned, but Abercrombie is still the bargain.
What about that cash? Abercrombie's hoard amounts to $572 million with no long-term debt, with $65 million in free cash flow (FCF) so far this year. The trailing year's FCF take is $225 million, giving the firm an enterprise value-to-FCF ratio of less than 13. That's already very cheap compared with the overall market. It's mind-boggling when you consider what a premium business this is: Abercrombie's margins are twice many of its competitors' -- such as Gap (NYSE: GPS) -- and its 18% return on assets and 25% return on equity would be enviable in any sector.
But if you buy now, you're not just getting a sluggish but stable kids retailer. A major catalyst is likely to be found in Abercrombie's new Ruehl line, which aims to cling to past customers by growing up with them past the mid-20s, if only just a little. The firm is launching this new concept this fall, built on a conceit that the store's roots extend to an immigrant family of German leather goods workers who settled in a Greenwich Village townhouse. Cheesy and overly contrived? You bet, but it sounds to me like just the kind of thing that young-ish American consumers -- raised on overtly scripted "reality" shows -- might learn to love.
The final nail in the coffin
Abercrombie's stock already looks cheap. If the new concept takes off, look out. There could be some frightfully big gains for shareholders.
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Seth Jayson
wore beat-up clothes and trucker hats long enough that they actually became cool, but not for geezers like him. At the time of publication, he had ownership interest in Aeropostale. View his Fool profile
here
.
The Motley Ghoul's Tricks or Treats represent the opinions of each Fool only and should in no way be taken as the opinion of either The Motley Fool, Inc. or any company in question, or as representative of anyone or anything other than that specific Fool's thoughts. So do your homework and review The Motley Fool's disclosure policy.
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