Don't Panic: Abercrombie's Issues Are Temporary

Clothing retailers have been mostly beaten down over the last few quarters due to worse-than-expected earnings and dismal sales outlooks. However, in certain companies, I believe that depressed share prices create an excellent opportunity to get into very solid brands at a discount.

In the sector, one of the best values right now can be found in Abercrombie & Fitch (NYSE: ANF  ) . Despite sales falling by about 12% year over year, most of Abercrombie's issues seem temporary, and the stock may be worth a look now.

Source: TD Ameritrade.

The apparel woes
Several high-profile apparel companies have had a particularly rough time this year. After reporting terrible numbers in August, American Eagle Outfitters (NYSE: AEO  ) dropped like a rock from the $20 range, bottoming out at about $13 in October.

However, since the end of the recession, sales have steadily climbed, and in fact the company's revenue for fiscal year 2013 was approximately $3.5 billion, about 14% higher than it ever was before the recession.

Even though there has been a noticeable pullback in consumer spending on apparel, the company's efforts to close underperforming stores, renovate existing stores, and develop a more disciplined inventory management should pay off for investors down the road.

Aeropostale (NYSE: ARO  ) is another major player that got hit by the slowdown. Although the company is not quite a direct competitor to the other two retailers (it offers lower-priced apparel and has a younger target demographic), many of the same issues have affected its sales and cut the share price almost in half from earlier this year.

Why Abercrombie's sales dropped in a growing economy
There are a few reasons Abercrombie's sales dropped during the current fiscal year (2014), most of which are temporary and beyond the company's control. This past spring was unseasonably cold in much of the U.S., which delayed and hurt demand for warm-weather clothes across the entire sector.

There has also been a dip in global consumer spending due to economic uncertainty (the U.S. government shutdown, Europe's economic issues, etc.), which has especially affected sales of nonessential and luxury goods. 

Abercrombie will be fine
Since the recession, Abercrombie has taken steps to make its business run more efficiently by cutting expenses and closing underperforming stores. At the same time, the company has been expanding into new markets, particularly in Canada, the U.K., and China. 

As a result, retail sales per square foot of store space rose from $339 in 2010 to $390 in 2011 and $463 in 2012, and finally to $485 in fiscal year 2013. This represents an increase of 43% in just three years, a dramatic increase in the efficient use of retail space.

As far as the most recent earnings report is concerned, most of the "loss" is related to restructuring the Gilly Hicks brand, certainly a short-term burden, but a good thing from a long-term perspective. Sales dropped 11.7% year over year, which is actually an improvement from the previous quarter. 

There were a few points of good news that required reading beyond the headlines a bit.  Direct-to-consumer sales (from the company's website) increased by 10% year over year, indicating that Abercrombie is doing a good job of shifting some of its business away from physical stores. The children's stores, Abercrombie Kids, only saw sales drop by 4% year over year, which is still a decline but much better than the bulk of the industry.

Should we get in after earnings?
Abercrombie is normally a very earnings-reactive stock. Take a look at the massive fall in the chart above, or the less drastic -- but still obvious -- moves at three-month intervals. The lack of a significant move after the most recent earnings announcement (which looked very weak on paper) tells me that most of the bad stuff is priced in at this point. Abercrombie shares are at their lowest price in more than a year, and this is still one of the dominant fashion brands in the world.

Abercrombie should have no problem making it through the temporary problems, and will emerge a stronger company than ever before 

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