Abercrombie & Fitch Co. Could Head to $20 as Retail Bounces

ANF - Abercrombie & Fitch Co. Could Head to $20 as Retail Bounces

Source: Ryan McKnight via Flickr

Well, it’s finally safe to say that retail is bouncing.

Many retailers, including Abercrombie & Fitch Co. (NYSE:ANF), have staged huge rallies since November, thanks to general giddiness in the retail sector. A slew of positive retail earnings reports, lots of healthy holiday sales guides, a ton of upbeat Black Friday/Cyber Monday sales commentary, and strong macro consumer spending data have come together to paint an unusually bullish picture of retail stocks.

Oh, and there is the whole corporate tax reform tailwind which would be huge for retailers, who are normally big taxpayers.

The simple truth is that while retail stocks were left for dead, they shouldn’t have been.

Brick-and-mortar retail isn’t dying; it is just shrinking. (There will always be demand to go to a mall and shop.) It looks like most of that shrinking is now in the rear-view mirror. Plus, all those sales going online weren’t going exclusively to Amazon.com, Inc. (NASDAQ:AMZN). Retailers aren’t dinosaurs who failed to adapt to today’s omni-channel retail world: They adapted. They built out their direct-to-consumer sales channels, and are now reaping the rewards of robust digital sales growth.

The numbers are finally starting to show this. Comparable sales trends across the board are improving. Promotions are peeling back, margins are stabilizing, and profit outlooks are brighter than they have been in a long while.

The result is a rising tide that is lifting all the boats in retail.

Teen retail is jumping. ANF, American Eagle Outfitters (NYSE:AEO), Express, Inc. (NYSE:EXPR), and Urban Outfitters, Inc. (NASDAQ:URBN) are all up more than 30% since the start of November (including a wild 60% rally for EXPR).

Big department stores are jumping, too. Nordstrom, Inc. (NYSE:JWN) is up 14% since the start of November, while Kohl’s Corporation (NYSE:KSS) is up 19% and Macy’s Inc (NYSE:M) is up 30%.

This rising tide will continue, so the challenge now becomes finding out which beaten-up retail stocks are positioned for the biggest gains.

ANF could be a fairly big winner. I think ANF stock looks good to about $20.

Why ANF Stock Can Head to $20

There is a lot of positive momentum at Abercrombie & Fitch Co. right now.

Comparable sales trends are improving in a big way. Total company comps have continued to trend up each quarter (-6% to -5% to -3% to -1% to +4%). Indeed, the third quarter’s 4% comp is the best mark ANF has reported in several years.

The upward trend in comps is being driven by a surge in popularity in the Hollister brand as well as a rebound in popularity in the Abercrombie brand. Hollister comparable sales increased 8% last quarter. That is by far away and the best comp Hollister has reported in several years. Meanwhile, Abercrombie comps have rebounded from down 14% one year ago to down just 2% last quarter.

With the Hollister brand surging and the Abercrombie brand rebounding to the flat-line, the sales growth outlook for ANF isn’t all that bad over the next several years. I think it’s likely that this retailer can grow sales around 1-2% per year over the next three years. That would put sales at just under $3.56 billion in three years, versus $3.4 billion expected this year.

Meanwhile, gross margins are still falling, but declines are moderating. It looks like gross margins can find a floor at 60%. Operating expenses continue to come out of the system, and the operating expense rate has been falling by several hundred basis points each quarter. Expense leverage is one of management’s priorities, so I think it’s likely this operating expense rate will continue to come down to about 55%.

That would imply operating margins of 5% for ANF in the future. That isn’t an unreasonable expectation. Peers AEO and URBN both operate at around 7-10% operating margins.

Interest expense usually accounts for roughly 0.5% of revenues, so I think pre-tax margins in three years will look like 4.5%. A 4.5% pre-tax margin on nearly $3.56 billion in sales implies pre-tax profits of about $160 million. Slap a 35% tax rate on that, and you get to net profits of about $104 million. Assuming 70 million diluted shares out, that equates to earnings per share of just under $1.50 in three years.

The five-year average trailing earnings multiple for the S&P 500 is about 18x. Throw that 18x multiple on $1.50, and you get a three-year forward price target for ANF stock of just under $27.

Discount that back by 10% per year, and you get to a fair value of just over $20 for ANF stock.

Bottom Line on ANF Stock

Right now, retail is a rising tide that is lifting all the left-for-dead boats that are retail stocks.

ANF stock is one of those boats. It’s already up big, but as sentiment normalizes and operational results improve, this stock could head even higher.

I think $20 is the level to watch for.

As of this writing, Luke Lango was long AEO, EXPR, URBN, and M.  


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