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Abercrombie & Fitch (NYSE:ANF) has come down sharply over the last 3 weeks. Yet, it still has a high PE of 27. Does it deserve that lofty PE? Other teen retailers such as Aeropostale (NYSE:AEO), American Eagle (AEO), Buckle (NYSE:BKE), and Gap (NYSE:GPS), have far lower PEs.


Does this company deliver the goods? Let's review its operating margins compared with its competitors. 2011 is in TTM form.

Abercrombie & Fitch, for all its reputation for selling pricey teen apparel, is at the low end of operating margins.

Let's look at historical operating margins. Abercrombie & Fitch fell off a margin "cliff" in 2007. Other competitors avoided that cliff, notably the Buckle.

Operating margins depend in large part on what the company pays for its overhead, or SGA. Let's view the SGA (sales, general and administrative costs) as a percentage of revenue. Again, we'll compare Abercrombie & Fitch with its peers. To be fair, companies account for their SGA expenses differently. We'll look at the historical numbers to avoid company specific accounting.

Over the last decade, Abercrombie & Fitch has seen its overhead costs rise as a share of its revenues. When compared with competitors, Abercrombie & Fitch sticks out like a sore thumb.

So, why has Abercrombie & Fitch been given such a high PE? Possibly due to its stellar gross margins. Abercrombie & Fitch has been a titan of gross margin, besting its peers.

These strong gross margins have given investors a reason to buy Abercrombie & Fitch. However, this quarter, Abercrombie & Fitch stumbled. Gross margins dropped 150 basis points. In addition, Abercrombie & Fitch expects further "erosion" in the back half of the year. Per its conference call, "We continue to expect gross margin erosion. However, our visibility on the magnitude of this erosion is less clear than in the first half of the year due to the uncertainties Mike spoke to earlier."

With Abercrombie & Fitch predicting weak gross margins, the stock has lost its last prop. Future earnings are seriously in doubt. Abercrombie & Fitch's high PE should be history. Snookie and Sitch can't save this one.

Disclosure: I am long BKE. I may initiate a short position on ANF at any time.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

Source: Why Abercrombie & Fitch's High PE Should Be History