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Abercrombie & Fitch (NYSE:ANF) made a surprise announcement at its investor day on April 5, 2011 by indicating that the company expects to report an EPS of $4.75 for the financial year ending January 2013. The company announced ambitious international expansion plans which would help propel the company to meet its 2016 revenue goal of $7.5 billion compared to TTM revenues of $3.46 billion. Not surprisingly, market reacted by rewarding the shareholders with 11% jump in stock price.

Notwithstanding the news, in my opinion ANF continues to be the second best teen retailer behind Aeropostale (NYSE:ARO). In this article, I will present the operational and profitability metrics for the three teen retailers that I closely follow, namely ANF, ARO and American Eagle (NYSE:AEO). I will also provide price targets for January 2013 based on my revenue and EPS estimates for three companies.

In my opinion, the best metric to evaluate the operations of any retailer is by analyzing and comparing the cash conversion cycle of the company to that of its competitors. Although the conventional cash conversion cycle consists of three terms (CCC = Days Inventory Outstanding + Days Receivables Outstanding (DRO) - Days Payables Outstanding), for a retailer, DRO is not a very important consideration (unless the retailer sells a substantial amount on credit). Hence, I typically exclude this term while calculating the CCC for retailers.

The table that follows presents the CCC for the three retailers identified above.

Cash Conversion Cycle (Days)

AEO

ANF

ARO

2006

21

82

14

2007

25

81

13

2008

27

78

13

2009

31

84

12

2010

31

65

12

Average

27

78

13

As shown in table above, Aeropostale runs a very efficient operation with an incredibly low CCC averaging 13 days providing ample liquidity. In addition to the low CCC, the yearly CCC for ARO is range bound and extremely consistent. AEO also sports a respectable CCC, however the CCC has increased during the last 2 years primarily due to an increase in inventories. Although ANF has the longest CCC, one thing that stands out is the drastic reduction in CCC from 2009 to 2010. This reduction of 19 days is again due to better inventory management by the company which implies improving operations.

Another important metric that I consider is average sales per square feet. Here again, ARO comfortably outperforms its peers by generating 45% more sales per square feet than ANF and AEO.

Average Sales / Square Feet

AEO

ANF

ARO

2008

$452

$390

$572

2009

$422

$339

$624

2010

$420

$432

$626

ARO has also delivered a very high and consistent Return on Invested Capital (ROIC). AEO is the only company of the three which has sequentially reported declining numbers. With improving sales and operations, the turnaround shown by ANF will most likely continue in my opinion.

Return on Invested Capital

AEO

ANF

ARO

2006

30%

35%

36%

2007

29%

31%

51%

2008

13%

15%

54%

2009

11%

0%

58%

2010

10%

8%

53%

Average

19%

18%

50%

Speaking of sales, the reason why ANF has significantly outperformed AEO and ARO is the dramatic (and unexpected) rise in revenues compared to its peers. During the last year, shares of ANF have gained 36% compared to a loss of 15% and 13% in the share prices of ARO and AEO, respectively. The table that follows presents the sales growth for the three companies.

Revenue Growth Rates

AEO

ANF

ARO

Last Quarter

-6%

27%

5%

Year on Year

-1%

18%

8%

3-Year Average

-1%

-3%

15%

5-Year Average

5%

4%

15%

ANF boasts of an accelerating sales growth while AEO is again a laggard in this category. I am most impressed by the historic growth rates of ARO based on the consistently upward trajectory.

Finally, looking at the margins (shown below), here again ARO is the only company with steady margins, although the average margins are fairly similar.

Operating Margins

AEO

ANF

ARO

2006

21%

20%

12%

2007

20%

20%

13%

2008

10%

14%

13%

2009

11%

4%

17%

2010

11%

7%

16%

Average

15%

13%

14%

Based on the information shown above, it is fairly clear to me ARO has historically been the superior company of the three companies analyzed in this article. However, valuation is still the key criteria in determining whether a good company makes a great or a lousy investment.

With the latest guidance from ANF indicating an EPS of $4.75 for fiscal year ending January 2013, I decided to estimate the future price for the three companies to determine the return possible from current levels. My financial year ending January 2013 revenue and EPS estimates for the three companies are shown below:

AEO

ANF

ARO

Revenue (millions)

My Estimate

3,149

4,995

2,656

Average Analyst

3,160

4,520

2,680

EPS

My Estimate

1.11

4.75*

2.82

Average Analyst

1.17

3.97

2.61

* - Company guidance

Next, based on historical analysis, I developed estimates for future P/E and P/S multiples using data from the last 10 years. The estimates and the resulting future fair values are shown below.

AEO

ANF

ARO

P/E

Estimate

15.94

19.04

13.83

Fair Value

$18

$90

$39

P/S

Estimate

1.22

1.70

1.25

Fair Value

$19

$94

$37

Average Price Target

$19

$92

$38

Current Price

$16

$66

$25

% Return

16%

41%

51%

* - As of April 5, 2011

Contrary to the saying in the world of investments, nice guys do not normally finish last. An investment in ARO, based on my estimates, is expected to return approximately 50% by January 2013 compared to a return of 16% in AEO. Based on my model, ANF is also expected to deliver solid returns. However, I consider ARO to be a safer investment based on consistent historic performance.

Disclosure: I plan on initiating a position in ARO in the near future.

Source: Teen Retailers: Which Is the Best Investment?