Value investors may look at Abercrombie & Fitch (NYSE:ANF) and find a buying opportunity because of its low debt and fairly low forward P/E of 10. However, I disagree and think Abercrombie & Fitch still has plenty of downside in its future. The brand has lost much of its prestige due to the tide of fashion tastes turning against it since 2008, yet the company's earnings are just a procyclical as other luxury brands. Due to a lack of stores in international markets, fading popularity among American youth, and the global macroeconomic slowdown, I expect Abercrombie to continue to underperform for the foreseeable future.
One strike against Abercrombie is its diminishing popularity among American youth. I have run private surveys among both the high school demographic and the 18-25 demographic, and the results have been unanimously negative. Perceptions of Abercrombie among youth include that the clothes are overpriced and uncool compared to newer brands, and there is a stigma attached to the personality type of people who buy this brand. (My sampling took place in a high-income part of the country.)
If consumers are going to pay luxury brand, preppy clothes prices, they are better off buying brands with more staying power like Ralph Lauren, Lacoste, Louis Vuitton, or the more expensive Italian designers. Abercrombie caters to the same higher-income demographics as these other premium brands, but lacks the same cache. Also, since the 2008-2009 recession, the fashion of buying vintage clothes (i.e., new clothes that look old and beaten up) has fallen out of style.
The one risk factor for shorting Abercrombie & Fitch is its growing popularity in Japan and Singapore, which can carry on to expansion in China. In Asia, consumers are not aware of the American youth's transition away from the brand, and Abercrombie clothing has become a status symbol of upwardly mobile Singaporeans. Expansion into China will be a long-term boom for Abercrombie, but it will not come fast enough to help earnings over the next year.
In addition, Abercrombie's financial health is not as strong as it looks on its balance sheet. Although the company has very little reported debt, when you account for the capitalization of $2.6 billion operating leases, its adjusted debt-to-equity ratio is 0.5. That's does not put Abercrombie at a serious risk of bankruptcy, but it does reflect a truer picture of the company's level of leverage.
Technical analysis is also pointing to a pullback. The company's MACD (moving average convergence/divergence) recently crossed bearish and will shortly fade below the center oscillator. It is also at the top of a bearish channel that dates back to last August.
Overall, my outlook is bearish on Abercrombie & Fitch and I have a price target of $40 over the next three months. Consumer tastes are shifting away from the company's clothing selection, and the possibility of another global economic slowdown will hurt its position of being one of the lowest-end companies in the highly cyclical luxury goods market.
Disclosure: I am short ANF.