Shares in Abercrombie & Fitch (NYSE:ANF) tumbled Friday in an otherwise up market after the struggling retailer said it would close yet more stores in an effort to boost profitability.
Too bad for A&F that traders’ immediate reaction to the news hewed closely to the old Wall Street saying that you can’t cut your way to growth.
ANF stock has tumbled 40% during the past three months despite a slash-and-burn policy to its store base. The company said it would shutter another 180 U.S. stores over the next few years on top of the 135 locations already closed in the past two years. The additional closings represent more than 10% of the company’s store base as of the end of last quarter.
At first glance, closing stores might not make much sense, since A&F’s troubles would hardly appear to be on the top line. Sales have increased more than 40% during the past two years, to $4.16 billion from $2.93 billion. Unfortunately for A&F, that only sounds good until you realize that top-line figures have a nasty habit of missing Street forecasts.
Besides, more worrisome is the company’s increasingly pressured margins.
The world of youth fashion is fickle enough. Throw in staggeringly high unemployment among its customer base, and A&F finds itself in a fight against price-slashing promotions, discounts and sales on all sides — all of which means there’s less money to flow to the bottom line.
At the same time, costs for raw materials have ballooned. Cotton, for example, has dropped precipitously from record levels notched last year, but prices still are up about 45% since 2009.
Furthermore, a lot of the revenue growth that A&F has enjoyed has been driven by its stores overseas. But with much of Europe in recession or struggling with tepid growth, that spigot has been drying up.
Since margins at U.S. stores are lower than those at locations overseas, A&F is scaling back at home. Fair enough. The company says the store closures should be accretive to earnings, but it looks to need more help than that, especially in light of wider economic worries.
For its most recent quarter, A&F posted a sharp drop in earnings, hurt by weakness in Europe and a decline in the all-important metric of same-store sales.
But even more important from the market’s perspective is that the company keeps blowing analysts’ estimates.
ANF has missed the Street’s bottom-line forecast for two of the past three quarters, as well as for its most recent fiscal year. Sales, meanwhile, have come up short for two quarters in a row, and in four of the past five fiscal years.
Hardly the sort of thing that gives a stock any kind of a tailwind — and the company’s most recent news only adds to fears that management is behind the curve in dealing with its challenges.
Anytime a stocks falls as far and as fast as A&F’s has, you expect it to look like a bargain on a relative valuation basis. And, at least by the forward price-to-earnings ratio (P/E), that’s absolutely the case here. The stock sports a forward P/E of just 7. That’s nearly 60% below its own five year-average and about 45% cheaper than the broader market.
But that doesn’t make A&F a buy. Sometimes stocks are cheap, and sometimes they are cheap for a reason. A&F might turn things around eventually, but for now it looks more like a value trap — a stock that looks like a screaming bargain and stays that way.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.