The total lack of investor confidence in U.S. brick-and-mortar retail is epitomized by Abercrombie & Fitch Co. (NYSE:ANF) stock. And it’s likely that shareholders’ best chance at redeeming any value in ANF stock will come this Thursday, when the retailer reports its first-quarter earnings.
How bad are things at Abercrombie?
- ANF shares are worth roughly 85% less than their all-time highs back in 2007.
- The stock currently trades near 16-year lows.
- Abercrombie & Fitch pays a dividend of 20 cents per quarter, good for a yield of 6.4%. But the payout hasn’t budged since 2013, so the high yield is a function of falling share prices, not a growing dividend. It also implies that the market expects a cut at some point.
- Most notably, the biggest jump in ANF stock of late was a 12% move higher a couple weeks ago when the company confirmed reports it was in negotiations for a sale. (Abercrombie has quickly given up all those gains and more.)
The market’s skepticism toward A&F and the potential of a sale make the company’s Q1 report Thursday all the more important. Most hopes of a sale will be dashed if the results lead to a reduction in already-tepid full-year guidance.
But a solid report — particularly in the Hollister brand — could support the idea that a strategic buyer might be interested in buying Abercrombie & Fitch. Even a “good enough” quarter likely spikes ANF stock.
The question is whether Abercrombie can do it. Few mall retailers have of late.
An Abercrombie Takeover Seems Crazy …
On its face, a takeover of Abercrombie & Fitch seems close to absurd. Most mall retailing stocks have been on the decline for some time — and that pressure has hit mall owners as well.
Class B mall owner Washington Prime Group Inc (NYSE:WPG) trades at less than 5x its 2017 FFO guidance. CBL & Associates Properties, Inc. (NYSE:CBL) trades at under 4x its guidance and yields almost 14%. Class A mall owners like Macerich Co (NYSE:MAC), Simon Property Group (NYSE:SPG), and GGP Inc (NYSE:GGP) have seen their stocks decline as well.
Clearly, the market believes that retailers are going to aggressively close stores. Indeed, Abercrombie & Fitch already is shrinking its footprint, closing 54 stores last year and guiding another 60 closings in 2017 — nearly 7% of its total. A substantial number of leases are expiring in 2018 as well, giving ANF even more flexibility.
Still, in the current mall environment, there seems little reason for anyone to take on any additional leases. ANF has more than $1.5 billion in commitments remaining, per its 10-K. And the last major takeover in mall retail was an unmitigated disaster. Ascena Retail Group Inc (NASDAQ:ASNA) bought Ann Inc. for $2.1 billion in 2015. Two years later, ASNA stock is at $2, and its market capitalization is under $400 million.
… Crazy Like a Fox?
The weakness in the sector as a whole would seem to dissuade any potential acquirer. So would Abercrombie & Fitch’s recent results. Same-store sales declined 5% in fiscal 2016 after a 6% drop the year before.
But there is a reason why Abercrombie might be of interest to strategic acquirers.
As poor as overall comps look, the company’s Hollister brand actually is hanging in. Same-store sales in that concept were flat each of the last two years — a reasonably strong performance given mid-single-digit annual traffic declines (at least) at most U.S. malls. Hollister actually generates more than half of total ANF revenue, and should have some value.
The A&F brand is still a mess in the U.S., with comps down 11% last year and 6% the year before. But it has some cachet overseas, and expiring leases could allow an acquirer to cut rent and labor expense rather quickly.
An acquirer like Express, Inc. (NYSE:EXPR) or American Eagle Outfitters (NYSE:AEO) could cut costs, milk A&F for cash, and try to optimize Hollister. And with ANF as a whole still posting impressive gross margins — almost 62% in FY16 — Express or American Eagle could add ~$1.9 billion in annual gross profit for a little more than $1 billion, even if it paid $20 for ANF stock.
Bottom Line on ANF Stock
You can make the case for an Abercrombie buyout. And with both AEO and EXPR at multiyear lows, their respective management teams may be desperate to do something.
It only takes one buyer to make a deal.
But Abercrombie & Fitch needs to show a decent Q1 to keep those hopes alive. That puts a lot of pressure on a quarter that hasn’t been particularly kind to the few retailers that have reported so far. Even mall bellwether Foot Locker, Inc. (NYSE:FL) struggled, blaming later-than-expected tax refunds. And it means ANF stock likely will move sharply after the report. The options market is pricing in a 12% move — and that might be conservative.
Personally, I’m too bearish on mall retail to expect Abercrombie to surprise to the upside. But it’s worth remembering that ANF probably doesn’t need to beat expectations — just come close enough to keep buyout hopes alive. If it does, the narrative around A&F changes.
If Abercrombie & Fitch misses, however, look out below.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.