Now might be a good time to look at Abercrombie & Fitch (NYSE: ANF ) . Why? For a few reasons:
- The stock is now trading at $36.75 versus its 52-week high of $77.49.
- The company is expected to report Q2-2012 earnings on August 15, when several positive catalysts are expected to be announced.
- The company recently announced a restructuring plan at the Deutsche Bank conference.
- An aggressive stock buyback by management might be a reality in the near term.
Abercrombie & Fitch has four brands, namely:
- A&F: Abercrombie & Fitch, which is rooted in East Coast traditions and Ivy League heritage. A&F is the essence of privilege and casual luxury.
- A&F for Kids: Casual, with classic, preppy style, Abercrombie kids aspire to be like their older sibling, Abercrombie & Fitch.
- Gilly Hicks: Gilly Hicks is the cheeky cousin of Abercrombie & Fitch. Inspired by the free spirit of Sydney, Australia, Gilly Hicks is the All-American brand for intimates.
- Hollister: Hollister is all about hot lifeguards and beautiful beaches. Young and fun, with a sense of humor, Hollister never takes itself too seriously.
At the end of Q1 2012, A&F had a total of 1049 stores, out of which 107 were non-U.S. based.
ANF shares reflect a weak environment in Europe, a weak global spending environment, and a lack of visibility with the new restructuring plans announced. The stock is currently trading at 10.5 times consensus EPS estimate of $3.375 versus its closest competitor American Eagle Outfitters (NYSE: AEO ) , which trades 16.8 times, and Aeropostale (NYSE: ARO ) , which trades 15 times. ANF also trades at a discount to the less obvious retailers Gap and Urban Outfitters. It's tough to make huge bets on teen retailers in this environment, but given where the stock is trading and the possible short-term catalysts that will be announced in the Q2-2012 conference call, this one is worth the attention.
Low barriers to entry and the weak economic environment
We do believe that A&F now competes with companies such as Wal-Mart, Costco, and Target as consumers cut back on spending given the weak global economic environment. The reason we don't put them all in the same peer group as the 3 A's (Aeropostale, American Eagle, and A&F) is that their product line consists of other products in addition to clothing, and we define Wal-Mart, Target, and Costco as big-box discount retailers. Others in the peer group, though, are Forever 21, H&M, and Topshop.
A gloomy back–to-school inventory
Although ANF is now stocked with back-to-school inventory, the selection of inventory is a real bummer. Heavy items such as wool blazers and sweatshirts just do not sell in June, July, and August. We did a channel check recently, and these items are already discounted at 30%-40%, which will have a significant impact on ANF margins, which have been on a steady decline. Also, we saw additional 75% off clearance items, which is rare for this time of the year, when we never see discounts more than 50%. All in all, the product hasn't changed year over year, which doesn't give the consumer the incentive to rush to A&F instead of shopping at multi-brand retailers such as Target and Wal-Mart.
On a positive note
Management has made statements on benefits realized with the reduction of cotton prices. Although we need more details on the pricing and how it would impact EPS and margins, this could be a positive for earnings.
A&F plans to close 180 stores by end 2015. Cost-cutting is definitely something we like here, but once again, we need more color on why these stores are being closed. Are they losers, are the leases expiring, or is management just preparing for a further cut in global consumer spending?
A&F has a strong balance sheet with $322 million in cash and no public debt. On July 22, 2012, A&F entered into a new $350 million unsecured credit agreement. As off end Q1-2012, there was $0 outstanding under the credit agreement, and the company was not in violation of any covenants. The credit agreement can be used for working capital and general corporate purposes, which gives the company a lot of flexibility. Additionally, in February 2012, A&F entered into a $300mm term loan agreement, which has been unused as off Q1-2012.
Last but not least, if management is expected to be aggressive with stock-buybacks, it's a good sign. Maybe management believes the stock is undervalued.
In conclusion, we look at this as a great opportunity to follow a company with a solid balance sheet, possible short-term positive catalysts if management plays their cards right, and an undervalued stock in the retail space.
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Written by Sabina Bhatia.