Consumer retail has recently been one of the strongest performing sectors in the US market. The SPDR S&P Retail ETF (XRT) has returned almost 38% over the past 12 months. Hence, given the significant valuation run-up, investors should stay selective when establishing exposure to the sector. In this article, I will walk you through my key thoughts on two stocks - Guess (GES) and Abercrombie & Fitch (ANF).
Guess shares have returned 30% year to date, and they are currently trading near the 52-week high achieved in August 2012. However, I think potential buyer should stay on the sideline based on the following reasons:
1. Guess shares are expensive relative to the comps. According to the table shown below, Guess' consensus revenue, EBITDA, and EPS estimates are all below the peer averages. On the profit side, most of the company's profitability margins and capital return metrics are also below par. In terms of leverage and liquidity, Guess carries almost no debt, but its free cash flow margin is again below the peer average. Both the firm's current and quick ratios are above par, reflecting a healthy balance sheet condition.
Despite the weaker financial performance, Guess' forward EBITDA and EPS multiples are on average 7% above the peer-average trading multiples. After accounting for the 5-year earnings growth estimate, the stock's 5-year PEG ratio is even 30% higher, suggesting the stock is somewhat overvalued on a relative basis (see chart above).
2. From a historical standpoint, Guess' valuation also appears to be stretched. The stock's trailing P/E multiple is approaching its 3-year high and is at a 38% premium over the 3-year historical average (see chart below).
Nevertheless, Guess' consensus quarterly EBITDA margin estimates are only showing a modest recovery to its historical level (see chart below). In addition, the company's consensus revenue, EBITDA, and EPS estimates for the next few quarters remain somewhat depressed relative to their historical figures in 2010 and 2011 (see chart below).
3. In a Jefferies research note dated May 31 (following the company's quarterly earnings release), Randal Konik commented on his concerns, which I believe to be fair (sourced from Thomson One, Equity Research):
Although business improved slightly, Europe remains pressured by economic weakness and poor consumer sentiment, especially in Italy and France…Key executive positions remain unfilled (CFO, COO), making it difficult to restore confidence in the viability of management's turnaround efforts…Additionally, management took a cautious tone on Asia given political tensions in South Korea and a slowing China economy.
Abercrombie & Fitch
The share price of ANF has risen by 61% over the past 12 months and is also trading near its 52-week high. Unlike Guess, I believe ANF share price still has a solid upside potential based on the following:
1. Based on the similar comp set (see below), although ANF's revenue growth potential is below the peer average, its EBITDA and EPS growth estimates, especially the 5-year EPS growth figure, are considerably above par. ANF has a below-average margin performance. The company's liquidity position is healthy as its free cash flow margin is above average and both its current and quick ratios are above par.
ANF's forward EBITDA and EPS multiples are trading at an average discount of 10% to the comps multiples. The stock's PEG ratio is even 33% below par. Given ANF's robust earnings growth potential but mediocre profitability, the current discount appears to be somewhat exaggerated (see chart above).
2. ANF's margin has improved by more than 7% in Q1 on year-over-year basis, and the margin expansion is likely to continue. Management announced that they have identified an annual cost savings of about $35M to $55M from general and marketing expenses, and they are currently in the process of quantifying further savings from the supply chain and store operations. It is expected that more details will be communicated in Q2 earnings.
3. Sell side is quite bullish on the stock. Of the total 29 analyst ratings compiled by Thomson One, there are 11 strong buy and 6 buy ratings.
Bottom line, ANF's risk-reward remains favorable due to its relatively cheaper valuation, even after the strong price performance. On the other side, Guess' price run-up has markedly eroded the investment's margin of safety. As such, buyers should wait for a pullback.
All charts are created by the author and all financial data used in the article and the charts is sourced from S&P Capital IQ unless otherwise specified.