Time To Buy Abercrombie & Fitch On The Dip

Aug. 9.12 | About: Abercrombie & (ANF)

Shares of Abercrombie & Fitch (NYSE:ANF) have declined 61.3% over the past 12 months. The plunge has sent the stock valuation close to its 52-week low measured by both forward P/E and EV/EBITDA (see below). I believe the market is currently over-discounting the negativity surrounding the firm and the stock is thus undervalued relative to the firm's solid fundamentals.

Click to enlarge

I will perform a comparable value analysis to illustrate the rationale that supports my bullish view on the stock.

My analysis includes a set of fashion retailers primarily based in the US as ANF's comparable peers. The estimated ANF stock value is then determined by equally weighting the valuations calculated by four peer average multiples - EV/Sales, EV/EBITDA, P/S, and P/E.

The following three paragraphs are based on the table shown below:

Click to enlarge

The firm's brightest spot is the growth potential. Consensus growth estimates remain strong as they predict revenues, EBITDA, and EPS to rise by a 2-year CAGR of 7.2%, 12.7%, and 50.8% over the current and next fiscal years, which are significantly better than the peer averages. Accounting for the EPS growth, the stock only trades at a PEG of 0.5x, the lowest among the peer group, suggesting a huge valuation discount to the company's growth prospects.

ANF dominates its peers in gross margin. Compared with the second highest gross margin from Buckle (NYSE:BKE), ANF's margin of 60.1% is still substantially higher, indicating that the company has done an excellent job in controlling costs. But unfortunately, the company lags the peers in other margin and capital return measures due to relatively high operating expenses.

In terms of liquidity, ANF also underperforms in cash flow generation as its FCF margin is in a negative territory while all of its peers are able to generate positive free cash flows - although just marginally positive. However, the company carries very little debt, which helps it maintain a fairly healthy interest coverage rate at 34.5x. Although both the current and quick ratios are below averages, they remain sound on an absolute basis. In addition, investors should also note that ANF's current net cash position of $294M amounts to approximately 12% of the current market cap.

As such, it makes sense for ANF stock to trade at discount valuations given its lackluster financial performance, especially for the profitability. However, the discount should not be significant as the firm's strong growth potential should deserve some credit. Nevertheless, the current stock price of $29.99 implies a substantial average of 46% discount over the four peer average valuation multiples, making me believe the stock price is overly discounted (see below).

Click to enlarge

The stock has a decent 2.3% dividend yield, which is one of the highest dividend levels in the peer group. There is also a sizable stock buyback program. Over the last 12 months as of April 30, the company has repurchased shares at a value of $330M. These shareholder-friendly policies clearly reflects management's commitment to return capital to shareholders.

Moreover, the company has recently started its expansion in Asia (especially for Greater China). With a growing middle-class consumer spending in that area and ANF's solid brand equity, the successful penetration would likely serve as a major medium-term catalyst for the stock.

Bottom line, I believe ANF remains a solid growth company. The current downturn creates an excellent opportunity of buying on the dip. I strongly recommend acquiring the shares at the current price or selling out-of-money put options to establish a long position in the stock.

P/E and EV/EBITDA chart is sourced from Capital IQ, all tables are created by author, and all financial data is sourced from Morningstar and Capital IQ.

Disclosure: I am long ANF.