Four Reasons Why Abercrombie Is Trading at a Discount

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Abercrombie & Fitch (NYSE: ANF), the specialty retailer of casual apparel, last reported earnings on Feb. 22. Gazing back at the fourth quarter and full year earnings announcement and the trajectory of the company's share price, Abercrombie seems to have fallen victim to the classic Wall Street "pump and dump."

From mid Jan. through Feb. 21, Abercrombie's stock inched steadily higher, nearly touching its 52-week high of $54.05. Then, as soon as earnings were announced, the stock headed south like U.S. downhill skier Lindsey Vonn, hitting nearly $45/share, good enough for a ~15% decline. This steep sell-off flew in the face of positive news that the New Albany, Ohio-based company delivered record fourth-quarter sales, met top-line revenue guidance, beat earnings estimates and posted strong full-year results. Below are four reasons why now is a nascent time to consider buying Abercrombie & Fitch.

1. Retail sales are regaining their footing
On Mar. 13, the U.S. Commerce Department reported a 1.1% increase in retail sales for the month of Feb. 2013, the fourth consecutive month of gains. This unexpected rise means consumers are regaining confidence in the American economy. To bolster the retail sales story even further, the Commerce Department also reported that U.S. business inventories in Jan. 2013 also grew by 1%, suggesting that American companies are seeing increased demands for their products. 

A senior economist with Capital Economics, Paul Dales, believes "the pickup in both employment and earnings growth bodes well for consumption growth later in the year." It appears that Abercrombie will finally be working against a rosier economic backdrop, which should result in stronger growth in the quarters ahead, along with an escalating stock price.

2. Abercrombie is trouncing peers in gross profit
Let us quickly run down some peer retail comps on Abercrombie, starting with Abercrombie itself. The trend-setting retailer, adored by the teen and tween audiences, has a trailing P/E (ttm) of 14.84, a price-to-book (mrq) of 2.16, and a gross profit of $2.52 billion, according to Capital IQ. Aeropostale (NYSE: AEO), Abercrombie's arch rival, enjoys significantly higher business valuations with a trailing P/E of 16.85, a price-to-book of 3.18, and gross profit of just $1.39 billion. Let me reiterate that last data point again, for emphasis. Abercrombie delivered gross profit of $2.52 billion, 45% higher than Aeropostale--with nearly the same number of storefronts and a comparable market capitalization.

When you add Philadelphia's Urban Outfitters (NASDAQ: URBN) to the mix, Abercrombie's current valuation appears even more out-of-whack. Urban boasts a trailing P/E of 24.25, a price-to-book of 4.32 and gross profit of just $860.54 million. All of these metrics easily make the case that Abercrombie is trading at a considerable discount to its peer group.

3. Margins are being managed to the upside
Abercrombie's gross profit rate, a key metric for apparel retailers, clocked in at more than 63% for the fourth quarter. This figure is completely unmatched by competitors, with Aeropostale 2,000 basis points behind at 40% and Urban Outfitters lagging the pack at just 37%. Even America's bellwether apparel retailer, The Gap (NYSE: GPS) clicks in at just 39%. On a year-over-year basis, Abercrombie greatly improved its gross profit rate by more than 9% by decreasing average unit costs, marking down carryover inventory in the prior year and buckling down with "continued tight expense control," according to Abercrombie CEO Mike Jeffries in the company's Feb. 22 press release. 

4. International efforts are driving revenue gains
According to Abercrombie's fourth quarter earnings report, international sales were the big breadwinner for the company in 2012, increasing 36% to $1.424 billion (representing nearly a third of Abercrombie's top-line revenue) for the full year. The company will continue to capitalize on this trend in fiscal 2013 by opening flagship stores in Seoul and Shanghai, as well as approximately 20 international Hollister storefronts. This follows a significant ramp-up overseas in 2012, when Abercrombie added 40 new stores. By the end of fiscal 2013, Abercrombie & Fitch should be operating ~160 stores internationally, more than 10% of its total retail locations.  

Abercrombie is offering significant value and strength overseas
To summarize, nearly a month after a strong fourth quarter and full year earnings release, Abercrombie is still trading in the mid-40s, while peer competitors are enjoying far higher business valuations on far lesser performance. Investors searching for an undervalued retail stock with strengthening sales, stand-out profit margins and effective international expansion would be wise to consider building a position in Abercrombie & Fitch. 

Julian Willis has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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