Abercrombie & Fitch Co. Stock Still Can Go Much Higher

ANF stock could rise another 20%

By Luke Lango, InvestorPlace Contributor

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Source: Ryan McKnight via Flickr

Abercrombie & Fitch Co. (NYSE:ANF) still is on the rise. ANF stock has risen strongly over the past six months, more than doubling from $9 to $20 as the company’s turnaround initiatives are starting to translate into improving financials. It just is more evidence that the retail surge continues!

Retail stocks started showing signs of life back in early November when rumors started to spread that the 2017 holiday shopping season was going to be a record one. Those same retail stocks started surging after strong Black Friday numbers rolled in.

And they kept tracking higher throughout December as more and more third-party reports rolled in confirming that holiday 2017 was shaping up to one of the best retail seasons in recent memory.

Now, in early 2018, those retailers are reporting actual holiday numbers. For the most part, they are pretty good. And most retail stocks are still on their upward trend.

ANF stock is now at its highest level since mid-2016. How much higher can this stock realistically go?

About 20% higher, but beware of near-term volatility.

Holiday Concerns For Abercrombie & Fitch

Most retailers reported strong holiday numbers. But not all retailers.

The results were mixed from Abercrombie’s peers. American Eagle Outfitters (NYSE:AEO) had a superb holiday season with comparable sales rising 8%.

Urban Outfitters, Inc. (NASDAQ:URBN) had a good, but not great, holiday season with comparable sales rising 2%. Express, Inc. (NYSE:EXPR) had a pretty bad holiday season with comparable sales falling about 1.5%.

Where does ANF fall in this wide spectrum? Judging by Google search interest trends, it looks like Hollister had a really good holiday season on par with American Eagle Outfitters and Urban Outfitters (search interest related to all the stores was relatively flat year-over-year during the holiday season).

But Abercrombie & Fitch’s search interest trends draw eerie comparisons to Express’ search interest trends (year-over-year declines), implying that the Abercrombie brand may have struggled like Express this holiday season.

That is a big risk considering ANF stock has more than doubled over the past six months. Just look at what happened to Express stock since they reported holiday numbers. The stock gave up all of its holiday gains.

That won’t happen to Abercrombie & Fitch stock because there is still the surging Hollister brand, but Abercrombie weakness during the holiday period could have a materially negative impact on shares in the near-term.

Long Term Fundamentals Imply Further Upside

Beyond the near-term, I think Abercrombie & Fitch stock is fairly valued around $24 per share.

The sales growth outlook for ANF isn’t all that bad over the next several years. The Abercrombie brand isn’t a growth segment, but declines are moderating. Meanwhile, Hollister continues to surge.

Overall, that combination should lead to 1-2% sales growth 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 Abercrombie & Fitch in the future. That isn’t an unreasonable expectation. Peers AEO and URBN both operate at around 7-10% operating margins.

Take out another 0.5% for interest expense, and that gets you to pre-tax margins of about 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 21% tax rate on that and you get to net profits of about $127 million. Assuming 70 million diluted shares out, that equates to earnings per share of just over $1.80 in three years.

Now that tax reform optimism will flow to the bottom line, it should come out of the valuation, and valuations should revert to long-term norms. The ten-year average forward earnings multiple for the consumer discretionary stocks is about 16x. Throw that 16x multiple on $1.80, and you get a two-year forward price target for ANF stock of just under $29.

Discount that back by 10% per year, and you get to a fair value of just under $24 for ANF stock.

Bottom Line on ANF Stock

Beware of near-term volatility (Hollister had a great holiday season, but I’m less sure about Abercrombie). ANF stock could be subject to weakness in the near-term.

But longer-term, strengthening fundamentals support a higher share price. I feel comfortable owning Abercrombie & Fitch stock below $24.

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


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