Trading Abercrombie into Earnings

Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Abercrombie & Fitch (NYSE: ANF) is scheduled to release earnings results for its most recent quarter before the opening bell on Wednesday. This tends to be a strange time of year for clothing retailers as the back-to-school rush has subsided and the holiday madness has not reached full swing. Given recent trends in profitability, revenues and analyst expectations, this could prove an important quarter in defining how the company’s expanded branding efforts continue to be received. Ultimately, while I like Abercrombie’s positioning, the stock is not strong enough to buy ahead of earnings. The company’s guidance will be more important this time than the numbers, but the numbers are expected to show solid positioning.

The Numbers

While Abercrombie has beaten analyst expectations for the past several quarters, the underlying numbers have not been particularly impressive. Rather, analysts seem to have had an overly pessimistic view of the company and its troubles. Last quarter the company reported earnings of $0.19 per share against expectations of $0.17. The beat is a positive, but at $0.19 Abercrombie still saw profits fall by 52% on a year-over-year basis, down from $32 million to $15.5 million. Revenue in the quarter rose by nearly 4%.

In the upcoming release, the company is looking to continue some trends and reverse others. As mentioned, the company has had a nice string of earnings beats and has seen several quarters of consistent revenue growth. The trend that most needs to be reversed is declining profit, which has plagued the retailer for some time. Consensus estimates are for earnings of $0.60 per share on revenue of $1.02 billion. These figures represent a 5.3% year-over-year earnings increase and an 11.3% year-over-year revenue increase.

Branding Strategy

Abercrombie came under fire several years ago when management suggested that its position as an aspirational brand made it immune from the reality of a sputtering economy. As the company stuck with its self-important approach, its sales figures made clear that the public did not agree. Since then, the company has adopted a far more reasonable approach to both merchandising and branding.

Abercrombie closed many of its underperforming stores, most of which were its premium Abercrombie & Fitch branded locations, and has accelerated expansion of other brands, specifically Hollister and ANF Kids. Where Abercrombie’s flagship stores have few direct rivals, the Hollister brand is more comparable to stores like American Eagle (NYSE: AEO), Aeropostale (NYSE: ARO) and The Gap (NYSE: GPS). Hollister tries to differentiate itself with the same flare for which Abercrombie is known; where American Eagle is the closest in brand approach, Aeropostale appeals to a younger contingent and Gap runs a much wider gamut.

Even within its iconic Abercrombie & Fitch stores (it is planning to open four flagship stores with one each in Dublin, Hamburg, Hong Kong and Munich) the company is updating its approach. With less focus on tops in favor of denim, and a new yoga/athletic line, the company is hoping to capture increasing revenues. The shift to athletic lines has been very successful for both Gap and Aeropostale, while American Eagle has maintained its focus on outfitting college kids.

The Trade

While Abercrombie is currently trading at a premium to its peers on a P/E basis (the company carries a P/E of 30.3 relative to 23.7 for American Eagle, 17.2 for Aeropostale and 18.7 for Gap), projected growth helps it to look more attractive. Abercrombie carries a PEG ratio of 0.74 relative to 1.04 for American Eagle, 1.18 for Aeropostale and 1.76 for Gap; the potential for Abercrombie to grow into its valuation looks promising.

Heading into the earnings announcement, however, the stock simply does not have the strength to warrant taking a speculative gamble. The significant stumbles that the company has had over the past several years have left it somewhat on probation – any bad news, or negative guidance, has the potential to be a catalyst for a sharp drop. As such, while I like the stock, I would wait to hear what management says about the way forward before initiating a position.

Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Aeropostale. Motley Fool newsletter services recommend American Eagle Outfitters and Gap. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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