Abercrombie & Fitch Co. (ANF, Financial) is a teen and young adult apparel retail company that has two primary brands – Hollister and Abercrombie. The company delivered good results for the fourth quarter in a relatively tough macroeconomic environment. While its stock performance has been good, there are a number of fundamental questions surrounding the company’s future, particularly the poor performance of its main brand, store closures and low valuation multiples. These factors make it an interesting pick for a more detailed analysis.
A decent quarter with revenue growth led by Hollister
Abercrombie recorded net sales of $1.16 billion for the quarter. While this was a drop of 3.15% from the prior-year quarter, the decline can largely be attributed to the impact of foreign exchange rates and the poor performance of the main brand. In addition, revenue actually managed to beat consensus estimates by $17.44 million. In terms of profitability, management reported earnings per share of $1.15, which was 20 cents higher than analysts' expectations.
The company’s revenues were led by the Hollister brand, which posted 6% comparable sales growth.
The retailer also recorded its ninth consecutive quarter of brand growth, with good performance across the jeans and pants, teddy, sherpa and fleece categories for both men and women. The Gilly Hicks lingerie line, as well as swimwear under the Hollister brand, also contributed to the growth.
By brand, Hollister contributed about 60% of the top line, while the remaining 40% came from a rather underperforming Abercrombie. In fact, Abercrombie recorded -2% comparable sales growth due to weakness in the women’s tops and dresses segments. Other categories, such as women’s pants, skirts, men’s knits and fleece, performed well, but the overall brand performance continued to be poor.
Company-wide initiatives driving profitability and future growth
Abercrombie is working to optimize its store network by closing underperforming outlets. The company has reduced its total fleet from 1,100 stores to 861, including 475 domestic store closures. This has resulted in positive growth in productivity per square foot as compared to 2017 levels. CEO Fran Horowitz has also directed the team’s efforts toward building a strong omnichannel strategy, which appear to be paying off as the retailer's digital sales for the year crossed the $1 billion mark. Online sales account for about 36% of the total top line, a slight increase from 34% in the fourth quarter of 2017.
Management also emphasized they are revamping marketing and loyalty programs to improve customer engagement and boost revenue.Â
The low valuation seems justified
While Abercrombie's initiatives sound impressive, the market values companies based on action and not words. The stock is trading with an enterprise value-revenue ratio of 0.42 and an EV-EBITDA ratio of 5.68, which is on the lower side. The price-earnings ratio is 24.45. The biggest factor responsible for the company's valuation is the negative top line and EBITDA growth over a three-year period. The falling revenue can be attributed to store closures, but the productivity is not good enough for the EBITDA to have improved. In fact, the three-year EBITDA growth rate was as low as -8.80%, which is why the stock has traded at below-average multiples.
While the stock appreciated by about 20% over the last 12 months, it had a lot of ups and downs. There is very little potential for multiple expansion given the current uncertainty. The stock's high beta indicates it is not a safe bet for investors with a medium-to-low-risk appetite.
Conclusion
The problem with Abercrombie & Fitch is it has grown too fast and is now focusing on closing unprofitable stores and optimizing its operations. The underperformance of the main brand is also affecting revenue. There is no real near-term catalyst that could boost the share price significantly, so it is best for investors to wait and watch to see if management is able to deliver on its promises before establishing a position in the stock.
