The apparel retail industry has been categorized by major swings in taste, style, popularity, customer demands and other trend-related topics. The boom-bust cycle has been typical throughout much of the industry’s history. One retailer that has seen its share of up and downs is Abercrombie & Fitch Co. (ANF, Financial). The company operates as a specialty retailer in the U.S. and internationally, doing business through two primary segments: Hollister and Abercrombie. Its brand labels include Hollister, Gilly Hicks, Social Tourist, Abercrombie & Fitch and Abercrombie Kids.
Abercrombie & Fitch was originally founded in 1892 as an elite outfitter of sporting and excursion goods such as expensive shotguns, fishing rods, fishing boats and tents. Interestingly, it outfitted Teddy Roosevelt's safari and Richard Byrd's expedition to Antarctica. Ernest Hemingway was also a regular customer. Then it transformed into a cultural clothing mecca for teens in the 1990s and early 2000s. Currently, the company operates over 750 stores worldwide.
The company expects to generate approximately $3.8 billion in revenue this fiscal year and currently has a market capitalization of $1.8 billion, which is quite the turnaround from its performance last year.
Transformation
Typically, the company’s retail stores appealed to the teenage demographic. But with low ongoing sales to the teen market, the company is refocusing its marketing efforts on the 22 to 45 age demographic. The new clothing lines offer a more mature, less teen preppy look than what had been its recent legacy.
The company also closed stores that were unprofitable while at the same investing in the remaining stores that worked. It focused on design and marketing for its new older demographic. This has been a long ongoing project; between 2010 and the 2018 fiscal year, the company closed 450 stores and remodeled others in an effort to reconnect with its targeted consumers.
Financial review
In the company’s fiscal first quarter ending April 29, it reported some of its strongest sales growth in a decade. Net sales increased 3.0% (or 4.0% on a constant currency basis) and was driven by 14.0% growth in the Abercrombie brand.
The gross margin was 61.0%, up approximately 570 basis points compared to the prior year period. The year-over-year improvement was primarily driven by lower freight costs and a 230 basis points improvement in average selling price. The gross margin was still negatively affected by inflation, in particular higher cotton prices and other raw material costs.
Adjusted earnings per share were $0.39 in the quarter compared to adjusted EPS of $0.27 in the prior year period.
Operating cash flow was roughly breakeven and capital expenditures were $46.4 million.
As of the end of the quarter, the company had cash and equivalents of $447 million. Inventories decreased 20% to $448 million. Long-term debt under the company’s senior secured notes was $300 million, which mature in July 2025. Borrowing available under its senior-secured asset-based revolving credit facility was $311 million. Total liquidity was approximately $758 million.
Valuation
The company recently provided updated guidance for fiscal 2023, and it now expects increased net sales growth in the 2% to 4% range. This assumes continued strength in the Abercrombie brand and an expectation that the U.S. will outperform international markets. The operating margin is expected to be in a range of 5% to 6%.
Consensus EPS from Wall Street is $2.06 for the fiscal year ending January 2024 and $2.47 for the following fiscal year. That puts the company selling at 17 times this year's earnings estimates and 14 times the following year’s earnings estimates.
The GuruFocus DCF calculator gives a fair value estimate of $38.00 when using $2.47 as the EPS starting point, a discount rate of 10% and projecting an 8.0% long-term growth rate. However, even in 2024, the company is not expected to reach peak operating margins, which I estimate may reach 8.0% over time.
The average price target for the eight Wall Street analysts that cover the company is $30.75 with a high target of $41 and a low target of $18.
Guru trades
Gurus who have purchased Abercrombie & Fitch stock recently (according to their 13F reports) include Ken Fisher (Trades, Portfolio) and Jim Simons (Trades, Portfolio). Gurus who have reduced or sold out of their positions include Paul Tudor Jones (Trades, Portfolio) and Lee Ainslie (Trades, Portfolio).
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
Summary
Abercrombie & Fitch is a historic retailer that has seen its ups and downs, changed its strategy multiple times and even faced bankruptcy at one point. The company seems to always reinvent itself somehow and set itself up for future success. New store openings and new brand development should drive low- to mid- single-digit revenue growth in the near future in my view. The lingering effects of the Covid-19 pandemic on mall traffic is still a real risk, but the company also has a thriving online business.
However, with the stock up 49% year-to-date, much of the positive expectations may already be baked into the price. I believe investors who are interested in the stock may be better off waiting for a reasonable pullback to create a margin of safety.
