Abercrombie & Fitch (ANF) reported net sales of $839 million for the first quarter of the current year, which was a decline of $82 million on a yearly basis. One of the primary reasons that led to the decline was a poor inventory management. Further, in the first quarter earnings call, the company's management gave guidance on the bottom line for 2013. They expect a full year diluted earnings per share, or diluted EPS, in the range of $3.15 to $3.25 for 2013. In this article, I will analyze the company's ability to achieve its EPS guidance in the current year.
Taking an average of the company's EPS expectation for 2013-- $3.20, and multiplying it with its trailing twelve months P/E multiple of 15.73, we arrive at a price of $50.33. To date, the company's stock has been trading in the range of $48 to $52 from mid of July, 2013. Therefore, I believe the investors have priced the company's stock on the basis of the EPS guidance of $3.20, with some minor adjustments.
At the current market price, ANF's stock is trading with an EPS expectation of approximately $3.07, which is slightly below the company's expectation. Now, I will do a bottom-up analysis to find out what should be the company's net sales for 2013 to generate an EPS of $3.07. For this, I will use the company's three year simple average net profit ratio and the gross profit ratio.
Here is a table which shows the net sales, gross profit, and the net income for fiscal ending 2012, 2011, and 2010.
Gross profit margin
Net profit margin
Amounts in USD ('000).
Source: Company s Annual Report 2012.
The company had 83.175 million diluted equity shares outstanding at the end of fiscal 2012. During the first quarter, it bought back 350,000 shares. This leads to 82.825 million equity shares outstanding on a diluted basis. Assuming, no further buyback is initiated by the company in the remaining 2013, the company will have to generate net income of $254.27 million to achieve a diluted EPS of $3.07.
= 82.825* 3.07
= $254.27 million.
The above table also shows a three year simple average net profit margin of 4.40% and a gross profit margin of 62.56%. On capitalizing the net income of $254.27 million with an average net profit margin of 4.40%, net sales comes to $5.78 billion. Further, with the average gross profit margin of 62.56%, gross profit on net sales of $5.78 billion comes to $3.62 billion.
Average net profit margin
= 5.25+3.46+4.48 /3
Capitalization of net profit to net sales
= $254.27 mn / 4.40%
= $5.78 bn
Average gross profit margin
= 62.44+61.33+63.92 / 3
Gross profit for 2013
= $5.78 bn * 62.56%
= $3.62 bn
On the basis of above calculations, I have drawn a pro-forma income statement of the company for 2013.
EPS based on current market price
Number of diluted equity shares
Average net profit margin
Average gross profit margin
Amounts in USD million except per share data.
The question now arises is that with the net sales of $839 million in the first quarter, will the company be able to generate additional net sales of $4.94 billion in the remaining three quarters, to justify its current market price?
On reading the company's first quarter earnings call and press releases, you will learn that the company is in the process of undertaking various initiatives such as better inventory management practice, consolidation of stores, and international expansion, to improve its revenue and reduce its operating cost.
Inventory management has been a problem for the company in the last few years. During 2011, the higher inventory level resulted in an excessive promotions and discounts, which led to a decline in the average price per unit. Since then, the company has been tightening its inventory policy. However, again in the current year's first quarter, its inventory level dipped too low that it led to a sharp decline in its comparable store sales.
Additionally, during the fourth quarter of the last fiscal, the company changed its method of accounting for inventory from retail method to weighted average cost method. According to the company's annual report for 2012, the reason for the change in inventory accounting principle is that the new method is consistent with the practices of other specialty retailers, thus will facilitate relative comparisons, and better aligns with the way the company is managed. Accordingly, the financial statements were retroactively amended, which resulted in a net income increase of $0.19 per share for fiscal year ending 2012. Apart from this, a team of company's top executives have been working to better align the growth of sales with the growth of inventory.
Consolidation of A&F stores and international expansion
The company closed down 47 A&F stores in 2012 and is expected to further close down 40- 50 stores in the U.S. in the current year. The closure of the A&F stores is expected to improve its revenue per square foot from $492 in 2012 to approximately $510 in 2013. This improvement is due to a lesser number of stores count in 2013 as compared to the previous year. Thus, the increase in the revenue per square foot won't have any material impact on the overall revenue of the company.
On the contrary, the company plans to open 20 new international hollister stores in 2013, which will total the number of hollister stores count to 600. The addition of the new stores is expected to generate an additional net sales of $88.6 million in 2013.
However, the company will be able to reap the benefits of the ongoing better inventory management practice from the next fiscal. Also, the consolidation of the A&F stores in the U.S. and the addition of 20 new hollister stores will not be contribute materially so as to enable the company to generate net sales of $4.94 billion in the remaining three quarters of the current year.
Besides this, Aeropostale (ARO) and American Eagle Outfitters (AEO)--two major competitors of ANF, recently updated their outlook on the expected EPS for the second quarter of the current year. Aeropostale now expects a loss of $0.45 to $0.42 for the second quarter as compared to the previous guidance of a loss of $0.20 to $0.15. On the other hand, American Eagle Outfitters also reduced its EPS guidance by $0.10 for the second quarter. The primary reason that led both these companies to reduce their earnings guidance was a slower than expected revenue growth in the second quarter. The weak consumer demand in the current year will adversely affect ANF's revenue as well.
ANF's current market price does not justify its revenue generating potential in 2013. I believe the company won't be able to achieve its EPS guidance of $3.15 to $3.25 in the current year. As mentioned above, a proper inventory management practice, consolidation of stores, and international expansion will not enable it to generate the additional net sales of $4.94 billion in the remaining quarters of 2013. Therefore, I believe the company's stock is currently overvalued at a price of $47.96.