Abercrombie & Fitch (ANF) – Buy, Hold or Sell?

Abercrombie & Fitch (ANF) – Buy, Hold or Sell?

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We think this is a good time to introduce Abercrombie & Fitch (ANF) 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 buy-back activity by management might be a reality in the near-term

Abercrombie  & Fitch has 4 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.

Quarter end Q1-2012 A&F had a total of 1049 stores out of which 107 were Non-US based.

Stock valuation:

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 10.5x consensus EPS estimate of $3.375 versus its closest competitor American Eagle Outfitters (AEO) that trades 16.8x and Aeropostale (ARO) that trades 15x .  ANF also trades at a discount to the less obvious retailers Gap (GPS) and Urban Outfitter (URBN) Its tough to make huge bets on teen retailers in this tough 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 name 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 (WMT), Costco (COST), Target (TGT) as consumers cut back 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 the 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 are Forever 21, H&M, and Topshop.

A Gloomy Back–to-school (BTS) inventory

Although ANF is now stocked with BTS inventory, the selection of inventory is a real bummer. Heavy items such as wool blazers and heavy hoodies just do not sell June-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 yr/yr 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 22nd, 2012, ANF 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, ANF entered into a $300mm term loan agreement which has been unused as off Q1-2012.

Last, but not the least, if management is expected to be aggressive with stock-buybacks, it’s a good sign. Maybe management believes that 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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