Once a mainstay of fashion-conscious teenagers, Abercrombie & Fitch (NYSE:ANF) has gone the way of MySpace, trucker hats, and everything else that fell out of style in the late 2000s.

But while the outfitter's glory days are over, its dividend remains a strong selling point. With a 4.8% yield and an aggressive share repurchase program, the stock is worth watching.

Is Abercrombie oversold?

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Abercrombie's third-quarter results revealed a stagnant, but relatively stable, business. Revenue held steady at $863.5 million, while net income declined to $0.10 per share from $0.35. U.S. sales increased by 4%, which was offset by a 6% decline in international sales.  

Management expects fourth-quarter sales and operating expenses to be up between 0% and 2%. If sales hold steady, fourth-quarter earnings may be similar to the $1.47 per share reported in 2018. Abercrombie's bottom line isn't growing, but the large end-of-year net income helps make up for the softness in earlier quarters.

How safe is the dividend?

Abercrombie pays an annual dividend of $0.80 per share. This comes out to a sizable yield of 4.8%. The dividend cost $52 million over the trailing 12 months, and the company generated $53 million in earnings over that same period, giving it a payout ratio of about 98% on TTM net income. 

That ratio looks high on the surface -- especially considering that Abercrombie posted a net loss in the first and second quarters of 2019   -- but net income often doesn't show the whole picture. Cash flow gives a wider perspective on the payout's sustainability on a cash basis. 

The following table shows Abercrombie's dividend coverage by free cash flow:

Year Free Cash Flow (Millions) Total Dividend (Millions)  Payout Ratio 
2014 $126.0 $61.9 49.1%
2015 $172.6 $57.4 33.3%
2016 $44.3 $55.1 124.4%
2017 $180.7 $54.1 29.9%
2018 $200.5 $53.7 26.8%

With the exception of 2016, the company's dividend has been well covered by free cash flow over the past several years. 

A large buyback program

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Abercrombie's dividend is coupled with a massive share repurchase program that should improve the company's per-share metrics and make the dividend more sustainable over the long term. The company reported 62.7 million shares outstanding in the third quarter, down from 65.8 million in that period last year.  An additional 4.6 million shares are eligible to be repurchased under the current authorization program. 

The buybacks have reduced Abercrombie's dividend expenditure from $62 million in 2014 to $54 million  in 2019. This is an excellent way for Abercrombie to deliver value to shareholders even though its bottom line isn't growing.

Looking forward 

Abercrombie and Fitch isn't the fast-growing fashion icon it once was. Sales are stagnant, and management is only guiding for flat sales growth going into fourth-quarter earnings. But the stock may be oversold, and it is worth watching at current prices.

Abercrombie's cash flow makes for a large, well-covered dividend, and its share repurchase program ensures dividend sustainability even if earnings remain flat. It's hard to see the stock falling much from current levels with these factors potentially acting as a floor on the price.