Abercrombie & Fitch May Be Ready To Take Off

Jun.28.12 | About: Abercrombie & (ANF)

For the last year, the share price of Abercrombie & Fitch (NYSE:ANF) has been diving almost relentlessly. After nearly touching $80 towards the end of last year, the stock price started to take a long and deep dive all the way down to $30 per share, and it currently sits there waiting for a catalyst to move it up. The catalyst may very well be the next 4 earnings reports.

After announcing a significant slowdown in profits in the last few quarters, the company decided to identify the least profitable stores in order to get rid of those stores. Very recently, the company announced that it would close another 180 stores in order to get leaner. The fact that the company is getting rid of its least profitable stores must be good news for the investors, however the investors of Abercrombie & Fitch didn't take it that way and the stock price continued to plunge.

In the last 12 months, the company has earned $1.18 per share (including a one-time charge of 88 cents), giving it a P/E ratio of 25. Many people may think that this is a large P/E for a company that is shrinking as opposed to growing at the moment; however the company's future numbers paint a prettier picture. By the end of this year, the company is expected to earn $3.55 per share, followed by $4.30 in the year after. These numbers would give the company forward P/E ratios of 8 and 7 respectively. Even if we assign the company a fair P/E ratio of 10, we are still looking at a huge upside potential in the next couple years. I find it funny that rating agencies rate this stock as "hold", yet they set price targets around $40 to $45 which indicates an upside potential of 50% in the next year. If they think the company has that much upside potential, why do they rate it as hold and not buy?

In the near future, the company probably won't see much same-store sales growth, however it plans to open a lot of new stores in order to replace the 300+ "weakest link" stores it is in the process of closing. We don't certainly know if the new stores will perform better than the closed stores, but again, if the company closed down its worst performing stores, then by definition, an average store will perform better than one of the closed (worst) stores. The company is likely to see most of its growth from Asia and Europe as opposed to the United States in the near future. The company is also expected to see some growth in its online market as more people are buying their products on the internet.

The company enjoys a strong brand name in North America, Europe and Asia -particularly in Japan- however this may be offset by the strong competitive pressure in the clothing market. Despite the hardships experienced by the company in the recent years, it has a relatively strong cash flow and solid balance sheet with $668 million in cash and only $58 million in long term debt. The company's cash flow of $360 million is easily able to cover the company's debt.

In conclusion, this may be a good time to initiate a long position in Abercrombie & Fitch. The current share price is only a few cents away from 52-week low and it is more than 50% away from 52-week high. Patient investors may see a lot of return in their investment within the next few quarters. Even if one has to wait for more than a few quarters to see real returns, the company pays for investors to wait as it has a dividend yield of 2.3%. In addition, due to high volatility in the company's stock price, the covered call writing can also prove to be lucrative for the investors.

I just initiated a small long position in ANF and I will be writing covered calls until the stock price recovers to high $30s.

Disclosure: I am long ANF.