Excitement Is Premature On Abercrombie & Fitch

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Abercrombie & Fitch (ANF) reported quarterly earnings late last week and it went very well, largely because of low expectations. The company reported revenue of $779.3 million which was flat Y/Y. It beat expectations on revenue by $20.7 million, but expectations had a 3% revenue decline built in. The company beat on earnings by $0.17; the accolades for an upbeat quarter flew and the stock was up over 25% post-earnings. The death of bricks and mortar stores has been much-talked about by the investment community. Abercrombie’s performance was a respite from all the downbeat talk of dying retail chains. I had the following takeaways on the quarter:

Hollister Continues To Outperform

The company’s same store sales declined 1% Y/Y. Normally that would be nothing to write home about. However, same store sales have shown marked improvement. In Q3 2016 same store sales declined 6%, and they have improved each quarter. The positive trend is something management can hang its hat on and potentially sell to investors in order to buoy the stock.

The Hollister brand continues to be a stalwart for the company and is symbolic that brands might still matter in retail. Same store sales for Hollister rose 5% and net sales rose 6%, making the brand an outlier in the retail apparel space. Foot Locker (FL) and Hibbett Sports (HIBB) experienced a sharp drop off in sales of premium sports apparel this quarter. I thought brand appeal could wane for Hollister, but it did not. The brand experienced high customer engagement and rising conversion rates. The company is focused on core categories customers are familiar with and have adopted. I like Hollister’s focused strategy. In theory it helps exploit customers’ affinity for certain products and allows for better inventory management – keys to managing apparel with a fashion-oriented bent.

Same store sales for the Abercrombie brand fell 7%, in line with year earlier results. Management is in the process of revitalizing the Abercrombie brand and reducing the number of SKUs. Again, having a more focused approach could help the company better management inventory and free up more time to generate customer feedback. Constant customer feedback about what teens like and do not like could potentially put a dent in the rate of sales decline. Management expects total comp sales to be flat for the second half of the year. Given past declines in comp sales this would be a major win for the company.

Strong Liquidity

At the end of July Abercrombie and Fitch had cash of $422 million. In a sagging retail market this is a luxury. Strong liquidity gives the company the flexibility to invest in inventory, remodel and invest in new stores or return capital to shareholders. Management intimated its major priority was to return capital to shareholders in the form of dividends and share repurchases. Its cash hoard could also help serve as a buffer if the shake out in retail continues. This is a key differentiator for the company in my opinion.

Conclusion

ANF currently trades at nearly 18x run-rate earnings (quarterly eps annualized). Talk of p/e expansion for ANF is premature in my opinion. I would like to see the company put together a few consistent quarters of revenue and earnings growth before getting excited about the stock. I rat ANF a hold at this juncture.

 

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