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Good Opportunity In ANF

|Includes: Abercrombie & Fitch (ANF)

Note:

  • First Quarter starts at the end of Jan with 13 weeks cycle.
  • Full year normally ends around Feb 1.

Abercrombie & Fitch sales reduced in the past two years by 8% (starting Q3 2013 till Q3 2014) while expenses increased dramatically in the follow period.
Cost of goods per sale didn't change much, average of 38% from sales, in last 5 years, however total expenses Increased significantly by 11%. The company started to restructure by cutting stores and distribution expenses since 2012.

As long as revenue returns below 4B dollars (in my opinion, sales estimation for 2014 should be 3.6B to 3.9B) they must stay focused and keep cutting expenses.

The follow table reflects revenues trend since 2010:

 

FY2014 (Q4 est)

FY2013

FY2012

FY2011

FY2010

International %

39.05%

35.29%

31.36%

24.44%

16.55%

us %

60.95%

64.71%

68.64%

75.56%

83.45%

US stores

$1,769,007.58

$2,161,183.00

$2,615,138.00

$2,710,842.00

$2,546,798.00

International Stores

$1,133,459.62

$1,178,798.00

$1,195,017.00

$876,616.00

$505,136.00

Direct

$815,761.80

$776,916.00

$700,651.00

$552,600.00

$404,974.00

Total

3,718,229.00

$4,116,897.00

$4,510,806.00

$4,140,058.00

$3,456,908.00

US stores %

-18.15%

-17.36%

-3.53%

6.44%

 

International Stores %

-3.85%

-1.36%

36.32%

73.54%

 

Revenues breakdown shows a huge trend in Abercrombie sales, 1) we see massive change between US store to international sores revenue (changed from 16.55% and 83.45% in 2010 to 39% and 61% in 2014) 2) direct to consumer huge growth which requires the company to rethink about store strategy, 20% of revenue (changed from 12% in 2010 to 20% in Q3 2014 and I am expecting the trend to Continue).

 

FY2014 (Q4 est)

FY2013

FY2012

FY2011

FY2010

Direct to consumer Growth

21.94%

18.87%

15.53%

13.35%

11.71%

Just to illustrate my point we can take a look on contribution of E-commerce retail sales to total retail sales over the past 10 years, Data taken from United state census bureau:

Last report support world trend regards to E-Commerce retail so I believe the company goes to the right direction and might increase operational margin by reducing heavy store expenses which could save the company proximately 10M USD on 1% cut. During 2014 I estimate the company will cut about 1% to 2%.

ANF must reduce general expenses at least by 10% in the future, it should contribute 130 million USD to operating income.
Let's compare current financial report to 2009 and 2010 by upper line.
We can see small change in gross profit margin since 2009 which could Contribute about 30M USD if the company will increase 2.14% in gross margin.

 

2014

2013

2012

2011

2010

2009

2008

2007

Gross margin

62.17%

62.56%

62.44%

61.33%

63.77%

64.32%

66.91%

67.25%

Fist the company needs to change concept dramatically and need to adapt internet era (understand Consumer behavior) and second they must extremely increase operational margin as you can find in the follow chart:

If I compare cost of good to sales around the industry we could see that ANF has lack of advantage because of major store and Distribution Expense:

 

2009

2010

2011

2012

2013

Nov-14

Average

ANF

84.37%

82.05%

82.44%

81.46%

83.78%

83.77%

82.98%

AEO

59.60%

59.90%

63.30%

60.00%

66.30%

63.07%

62.03%

Ges

55.77%

56.17%

56.99%

59.86%

62.01%

63.73%

59.09%

PLCE

59.87%

60.39%

61.56%

61.79%

62.88%

64.32%

61.80%

URBN

59.43%

58.81%

65.21%

63.09%

62.37%

64.30%

62.21%

GPS

59.700%

59.80%

63.80%

60.60%

61.00%

60.51%

60.90%

ZUMZ

67.32%

64.95%

63.72%

63.95%

63.86%

65.77%

64.93%

BOSSY

45.57%

38.27%

36.75%

38.44%

35.05%

34.73%

38.14%

From the macro point of view I don't believe the company has too many risks, I compare current situation to 2008 &2009.

In 2008 & 2009 the company had the same situation:

  1. Drop in sales, two year of growth decline (proximately 20%).
  2. Similar gross and operational margin.
  3. Global recession although US market should growth much faster than 2009 (Dec 2014 retail sales Declined 0.9%).
  4. Same yearly average stock price.

I do believe the company needs to cut dividend as soon as possible, last year they declare 0.8 per stock (61.9M USD) while the company earned 0.7 per share, full year.

This year the bottom line should be close to previous year with net income of 70M USD, dividend cut is Inevitable.

Regards to balance sheet, the company has solid asset to liabilities with 2:1 ratio. Total equity can cover all liabilities so the company is not leverage at all.
There are two thing which concern me a bit, 1) cash and equivalents which cut by half from 600Mio in 2013 to 320Mio at the third quarter. 2) Balance sheet indicate growth in inventories by 16% (617K), I believe the company will increase products sell through December like in previous years. On Nov 2013 the company releases inventories of 768.9Mio USD and 629.9Mio USD on Nov 2012.

Therefore cutting inventories depends on end of year selling and as I mentioned US retails sales fell in Dec.

If I take all parameters in conclusion I think Abercrombie & Fitch is a good investment for 27$, undervalued by market. The stock easily goes back to 31$ area, look at the follow chart (5 years/daily bars):

One more thing you should know, the company should release financial reports on Feb 25th 2015 so the stock might be volatile until then.

If you have concern for short run you should consider selling call (expiry before Feb 25th) versus extra long stock which could gives you buffer down side (Implied volatility 43%).

Disclosure: The author is long ANF.