Abercrombie & Fitch Stock: Buy, Sell, or Hold?

Abercrombie & Fitch's (ANF -3.86%) stock surged 31% on May 24, following its latest earnings report. For the first quarter of fiscal 2023, which ended on April 29, the apparel retailer's revenue rose 3% year over year to $836 million and exceeded analysts' estimates by $21 million.

Its adjusted earnings of $0.39 per share also topped expectations by $0.37 and marked a major improvement from its net loss of $0.27 a year ago. Those numbers were impressive, but should investors buy, sell, or hold Abercrombie's (A&F's) stock right now?

Image source: Getty Images.

What happened to Abercrombie & Fitch?

When Fran Horowitz took over as A&F's CEO in 2017, the apparel retailer was struggling with weak sales of its Abercrombie products. It was facing stiff competition from fast-fashion competitors like H&M and mall closures. Abercrombie initially targeted teen shoppers throughout its heyday in the 1990s and early 2000s, but its dated marketing campaigns, dimly lit stores, and big logo apparel failed to win over a new generation of shoppers.

To stem that bleeding, Horowitz expanded A&F's higher-growth Hollister banner while closing Abercrombie's weaker stores. She also refreshed Abercrombie's business with new marketing campaigns, renovated stores, products for older shoppers, and investments in its e-commerce channel. The company also expanded Hollister's smaller lingerie brand Gilly Hicks with new brick-and-mortar stores to compete against Victoria's Secret and American Eagle Outfitters' Aerie.

Those turnaround efforts initially seemed to stabilize A&F's business, but its top-line growth still decelerated in the years leading up to the pandemic. Its net sales rose 5% in fiscal 2017, 3% in fiscal 2018, and only 1% in fiscal 2019.

That slowdown was largely caused by Hollister's loss of momentum, especially among its female and overseas shoppers, and the company's ongoing closures of weaker stores. In fiscal 2020, its net sales plunged 14% as the pandemic derailed its fragile recovery and forced it to close its brick-and-mortar stores.

A&F's post-pandemic recovery was shaky. Net sales rose 19% in fiscal 2021 as it reopened stores but remained nearly flat in fiscal 2022 as inflation curbed consumer spending. Abercrombie's growth remained stable, but Hollister continued to struggle. Higher freight and material costs, along with persistent markdowns, also reduced the company's gross margin by 540 basis points to 56.9% in fiscal 2022.

Are brighter days ahead for Abercrombie & Fitch?

A&F's future seemed bleak throughout most of 2022. However, its return to sales growth over the past two quarters, along with the sequential and year-over-year expansion of its gross margin in the first quarter, contradicted that bearish thesis:

Data source: Abercrombie & Fitch. YOY = year over year.

A&F expects that momentum to continue with 4% to 6% year-over-year sales growth in the second quarter, as well as 2% to 4% sales growth for the full year. It had previously guided for just 1% to 3% growth for the full year. 

During the conference call, Horowitz attributed that acceleration to Abercrombie's "powerful brand transformation" and its brisk sales of women's apparel. She said that while Hollister's sales were still "not where we need them to be," the brand's "evolution is on track" with a "fresh" and "more balanced" assortment of back-to-school apparel.

Unlike many other apparel retailers, A&F isn't drowning in excess inventory. Its inventory declined 4% in fiscal 2022, then fell another 20% year over year in the first quarter of fiscal 2023 as it resolved its supply chain issues. 

As A&F sales growth stabilizes, its lower material and freight costs are boosting its margins. It expects operating margin to land between 2% and 3% in the second quarter, compared to its break-even operating margin a year earlier, and to expand from 2.5% in fiscal 2022 to between 5% and 6% in fiscal 2023. That's also higher than its prior full-year outlook of 4% to 5%.

A&F also reiterated the Always Forward targets, which it unveiled during its investor day last November. Those goals call for annual revenue to reach $4.1 billion to $4.3 billion in fiscal 2025. This implies its top line will have a compound annual growth rate (CAGR) of 3.5% to 5.1% from fiscal 2022 to fiscal 2025 and operating margin will exceed 8% by the final year. Over the longer term, the company believes its annual revenue will top $5 billion, with an operating margin of more than 10%.

A&F still looks cheap, relative to its growth potential

A&F's stock soared after its impressive earnings report, but it still trades nearly 50% below its all-time high and looks fairly cheap at 17 times forward earnings. Therefore, I believe A&F is a good stock to buy and hold in this choppy market -- and definitely shouldn't be sold with the market's other struggling mall-based apparel retailers.