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Yesterday, Abercrombie and Fitch (NYSE:ANF) got creamed on weaker than expected earnings report. The main cause is the slight miss in earnings (rounding) and weaker gross margins. While such problems are not helpful for the bulls, I do find the story compelling.

First, ANF broke out a few weeks ago and (this past month) on the weekly and long term charts. As of Wednesday morning, it has held the top of the previous range (which happens to be where I purchased it). Also, I believe this story is still strong as the company is expected to grow earnings to $5.48 a share in 2007 from the $4.60 range this year. At 13x earnings, ANF is trading cheap to growth.

As for the non chart and earnings catalysts, the company is expanding internationally which to me argues for sustainability (though some would call it stupid in some circles). According to Bear Stearns, the Canadian business is three times more productive than the US average. If this continues as ANF expands internationally, this should provide a support and enhancement to the income statement (as well as gross margins). With global growth slowing, such efficiency measures are very important and should growth the company.

As for the marketplace, I continue to believe that the retailers are being underestimated at the moment (the bearish stories continue). The bears are out claiming that the consumer is dead and perhaps they are using this as ammo to sell the stock market. I think this argument is incorrect. Given my expectation that energy is heading lower (or at least not accelerating in the near term), I think that the consumer is supported. While there is a risk in buying any stock up here at the current levels in the S&P and Dow (I prefer to buy on a dip normally), I think that given the breakout and the undervaluation, the stock should be supported. Also, since I think that ANF will hold the range, I don’t see a reason to wait and buy on a market dip.

Fundamental Story

As mentioned, I believe that ANF will end up earnings $4.60 (and possible more) for 2006 which is about where the market is positioned (company forecasted $4.56/4.60). I am looking for around $5.48 in 2007 which implies growth of 19%. Since ANF is trading at roughly 13x the 2007 number, the company is trading cheap to growth. At full valuation, I could see the stock trading to $95 (implying a 1x PEG rate). While I was concerned about the margin compression this quarter, I think it will be temporary. Inventories look pretty good (though this is a trend across the industry) so if there is a problem with sales forecasts, the pressure on margins will not be as significant.

Economic Impact

In comparing ANF to the yield curve of sorts, it tends to perform well when 10s are moving lower. Conversely though, if the short rate 13 week bill is on the rise, ANF tends to track the move well because if the 13 week is on the rise, this is an indication growth expectations are rising in the economy. Based on my current models, the 10 year is stable at the current level area while the 13 week bill turned lower but appears now poised to move higher. Relative to the action in the crude price, ANF trends to respond to the move in crude a few months after the move has begun. Thus, while crude is moving higher today (I figured such last week) I think this is just another test of the top and thus a support to ANF.

Since July, according to Yahoo!, downgrades and neutral ratings have been the norm (though Bear Stearns came in with an Outperform so maybe that is not updated as well as I would like). Since sentiment seems poor on this company (along with Jim Cramer who said to take profits), there does not seem to be much hope or conviction that the stock is heading higher. Further, short interest is close to 5% which should provide some support when the stock moves higher (hopefully) in the months ahead.

As mentioned in the opening, the technicals for ANF look good. The company has bounced off the previous highs a few times and held is successfully. This indicates to me that there is a buyer out there. In addition with the company buying back stock, that should support the region some more. Also the DM buying pressure is on the rise with selling pressure moving lower on the break. Using monthly targets, I would estimate that the next move for ANF is to $95 over the next 6 to 9 months. The weekly chart has a solid power model profile and argues for a similar target. Overall, the technicals are strong for ANF. Now let’s see the stock perform strong!

I like Abercrombie going forward and looking for a move to the $95 level. Interestingly enough, at 1x PEG, the price of the stock should be about the same so I have support on a valuation and technical standpoint. The one risk to my outlook is if the stock enters the old range below. Such a move would possible set up a bigger break back to the $50s. If the stock re-enters the old range, I will pull the trigger and close the position. Do I expect such to occur? Not at this point. That is why I am a buyer of ANF (and I have added it to the MIR 2).

See: Abercrombie & Fitch Q3 2006 Earnings Call Transcript

ANF 1-yr chart:

ANF chart