Abercrombie & Fitch Earnings – Behind The Headlines

By Chad Henage - May 31, 2012 | Tickers: ANF, AEO | 0 Comments

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I feel sorry for the analysts who follow Abercrombie & Fitch. (NYSE: ANF) I really do. I remember in 2005, the stock was selling for a 10-15 forward P/E and was expected to grow at about 20% a year. I owned the shares for a year or so, until I realized that in this case I couldn't believe the analysts at all. Not much has changed in the last seven years apparently. Abercrombie & Fitch today is expected to earn enough that the stock sells for about 10 times forward EPS projections, and the company is expected to grow at 19%. These expectations look just as questionable as the expectations before. 

In 2005 when analysts expected 20% growth, the stock was at about $54. It did have a nice run to about $82 by 2007, until the bottom dropped out. From a low in 2009 of about $18, it had another good run to about $75, again until the bottom dropped out. With the stock currently selling for $34.32 investors who've held on since 2005 are still sitting on a loss. I had all but given up on Abercrombie until recently when I looked at the company again. I figure it's never time to completely give up on a company unless they go bankrupt or get bought out by someone else. With Abercrombie filing their annual report not long ago, it gives us another chance to look behind closed doors and see what's going on with this retailer.

Positive Developments:

There are several positive developments with Abercrombie. First, the company's current dividend gives investors a yield of about 2%. That isn't a huge number, but in today's interest rate environment, this beats most CDs that you can buy. Second, the company increased its share repurchase plan by 10 million shares. Third, the company has been actively repurchasing shares. In the most recent quarter, the company bought back 3.3 million shares at an average price of $48.85 per share. Last, and most impressive the company's international direct to consumer sales were up 42%, and grew to represent 30% of revenues.

Opportunities:

Abercrombie same store sales are opportunity number one. The company seems to have hit a wall, and I don't know if the company even knows what happened. Look at the trend in comparable sales per store in the last few periods:

What I see is steadily declining same store sales growth that just slipped into negative territory. This isn't a small event, because in 2010 and all of 2011 the company saw flat to positive same store sales. Net sales were up 10%, almost completely due to new stores being added and the growth in direct to consumer sales. Negative same store sales were not isolated to just one brand either, which is worrisome. Abercrombie & Fitch comps were down 4%, abercrombie kids comps were down 11%, and the seemingly more popular Hollister was even down 5%. I also noticed that while the international direct sales division saw a 42% increase, the U.S. division of direct sales saw an increase of just 1%. Other opportunities that jumped off the page were: cost of goods sold was up 2.4%, and store and distribution expense was up almost 2%. With costs increasing 4.4% between the two, this hurt margins tremendously. The company's buyback of about 4.7% of outstanding shares is one of the only reasons Abercrombies' results weren't worse. Share repurchases are usually something I like to see if they are funded with free cash flow. However, Abercrombie didn't have the free cash flow to make these buys, and instead used about half of the cash on their balance sheet in the last year. 

Store Growth and 2012 Outlook:

When it comes to total stores, let's look at the breakdown, and the number of stores expected to be opened by the end of this year:

With a total of 1,045 current stores and just 44 expected to open this year, new stores should contribute at most 4.2% to sales. One big problem is, at this point the company expects same store sales to be down by the “mid-single digits for the full year”. You can't have 96% of your total stores losing sales compared to last year and expect to go anywhere fast. That being said, the company re-affirmed they believe they will meet the $3.50 to $3.75 EPS target for the year.

Conclusion:

The biggest challenge I see with Abercrombie meeting their $3.50 to $3.75 EPS goal is their revenue growth just doesn't appear to support these numbers. Analysts are expecting 11.60% revenue growth for fiscal year end Jan. 2013. I don't see that happening. If the company is only getting 4.2% growth from new stores, and they are losing say 5% in same store sales from 96% of their store count, where does this 11.6% growth come from? Last year Abercrombie had $4.16 billion in sales. The company says new stores will contribute about $250 million which makes this total $4.41 billion, that assumes no negative impact from negative same store sales. When the company expects at best 6% revenue growth and then you subtract 5% negative, same store sales you sure don't get 11%+ growth. Unless same store sales results turn around, I would avoid Abercrombie.

If you want an alternative, I've made the suggestion before to substitute American Eagle (NYSE: AEO) for Abercrombie. American Eagle is expected to grow EPS by about 12.5%, which is slightly lower than Abercrombie. However, compared to Abercrombie's negative 5% same store sales, American Eagle saw 17% same store sales growth. American Eagle has the same opportunity to expand their presence internationally, but while supported by a growing sales base domestically. I picked AEO to outperform the market back in February and it's up 38% since then. Even with this 38% gain, I still like AEO better than ANF.

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