Is Abercrombie’s Stock Price Rally Justified?

Abercrombie & Fitch’s(NYSE:ANF) share price has been soaring since its second quarter results announcement on August 24. In fact, the stock’s upward trajectory had started a couple of days prior to its earnings, buoyed on by the broadly positive reports delivered by other teen retailers. In a surprising development, these apparel retail companies did not perform as badly as many had anticipated. Abercrombie joined a list of retailers, including American Eagle, Urban Outfitters, Gap, and Express, who beat both top and bottom line expectations. While the results may not have been great, and the expectations itself had been muted, this small sign of a recovery sent the stock prices of these companies soaring. We’ll concentrate on Abercrombie in this article, and try to analyze what resulted in a rally of the stock price, and whether it is justified.

Were The Results That Good?

ANF beat the top and bottom line expectations in the second quarter. Given the weakness in the apparel retail market, as well as the poor past performance of the company, a substantial decline in revenues was expected this time around as well, along with an EPS of $-0.33. Teen apparel companies have suffered tremendously with the rise of the Amazon giant, and the decline of mall traffic. To cope with this, these companies have been focusing on their online channel, which has been pressuring the margins. A promotional environment and store traffic headwinds are an industry-wide headache, and ANF is no exception. The excessive discounting has wreaked havoc on the gross margins, which were 130 basis points lower in Q1 than in the corresponding quarter last year. All these factors combined prompted the expectation of a dismal quarter for Abercrombie.

The shares of Abercrombie were up 16% on the second quarter results announcement, and have risen further since then. The company reported a 0.5% decline in sales, and a 1% fall in its comparable sales growth, but an improvement in its earnings per share – loss of 16 cents, as compared to a loss of 25 cents in the prior year quarter. Sequentially, the comps improved by brand and by geography. Given this improvement, the back half of the year may result in positive comps growth. A&F estimates a growth in this metric to be approximately flat to up slightly in the second half. While the retail environment continues to remain challenging, the company has undertaken efforts to improve their product assortment, perk up their investments in marketing and omni-channel, and optimize productivity. All these steps bode well for a more upbeat second half.

Another factor to consider is that the shares of the company had been down significantly this year, particularly since the breakdown in deal talks with potential suitors, which included American Eagle. Abercrombie’s stock price had fallen from $31 to $9 in a short period of a year and a half. The stock was trading at $12.74 on September 1, while our price estimate is lower by 5% at $12.17.

Is The Rally Warranted?

While the second quarter results do show signs of improvement, the company seems to be far from an actual turnaround. The sales are still falling, and the company is still facing an operating loss. Furthermore, a closer look at the sales beat shows that the revenues were spurred on by a highly promotional environment. While this excessive discounting has resulted in higher than expected sales, it has come at the cost of reduced gross margins, which declined by 180 basis points in the quarter. If ANF had not resorted to reducing its prices, it would have been certainly faced with a significant drop in its sales. Looking ahead, the company has stated that it will continue to remain promotional in the second half of the year as well. This implies that the margins will continue to remain pressured for at least the next two quarters.

Despite the above stated problems, the company still has cash of $422 million, a luxury given the soft state of the retail market. Such a scenario gives the company the ability to invest in inventory and its remodeling initiatives, as well as expansion into new or relaunching of its earlier categories. An example of the latter is the relaunching of its Gilly Hicks brand, which witnessed aggressive growth of its swim and intimates line in the second quarter, and seems poised for success in the remainder of the year as well. In terms of investment in inventory, the company’s denim line seems to be the one that can benefit the most, as this segment noted a record performance among both genders. ANF also intends on returning cash to its shareholders through dividends and share repurchases. Hence, such a cash pile can help to soften the burden if the weakness in the teen apparel retail industry continues.

See our complete analysis for Abercrombie & Fitch

Have more questions about Abercrombie & Fitch? See the links below:

• Hollister Helps Abercrombie Beat Estimates
• Can 2017 Be A Good Year For Retail Stocks?
• Part 2: Is There A Way Out Of The Rut For Brick And Mortar Stores
• Retailing Conundrum, Part 1: Is There A Way Out Of The Rut For Brick And Mortar Stores?

Notes:

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap |More Trefis Research