Over the past year, Abercrombie & Fitch (ANF) has been focused on closing unproductive stores in its dominant market, the US, while opening stores and expanding its reach in Europe and Asia. Unfortunately for the firm, economic growth has been particularly weak in Europe and the rate of growth in China appears to be decelerating. Its US same-store sales grew 4%, but the weakness abroad contributed to aggregate same-store sales falling 5%. Since Abercrombie is a mid-premium brand; more prestigious than h&m or Zara, but less prestigious than Ralph Lauren (RL) or Coach (COH), its sales are highly sensitive to economic volatility. Thus, slowing the rate of store expansion in Europe and Asia in the near-term makes sense, in our view.
Abercrombie and its child company Hollister are essentially saturated in the United States market. Therefore, we like the plan to close unproductive stores that have come under pressure from cheaper fast-fashion competitors like Forever 21, h&m, and TopShop. We think the firm has a large enough store base that it won't run the risk of losing too much revenue, but the closings will certainly help the bottom line. The preferences of the US consumer are also slightly different than the Abercrombie consumer abroad. In the US, the brand specifically appeals to high school students and younger demographics. On the other hand, European and Asian consumers tend to wear the brand later in life, which, under normal economic conditions, makes this demographic extremely attractive. When economic activity in Europe and Asia accelerates, we think Abercrombie & Fitch will benefit tremendously.
As of its last update, the firm expects to earn between $3.50-$3.75 per share, meaning shares trade at less than 10x forward earnings, which is considerably cheaper than peers like American Eagle (AEO) and Urban Outfitters (URBN). More importantly, in our view, the firm also trades at a discount to our fair value range, which is $41-$77. If rumors of a substantial buyback are correct, then management also thinks the stock is undervalued. We are hesitant to bet on teen retailers, but given the compelling valuation and improving operations, we think shares look attractive at current levels. Once its score on our Valuentum Buying Index improves, we might look to add shares of the retailer to our Best Ideas Newsletter portfolio.