Shares of Abercrombie & Fitch (NYSE:ANF) soared on Wednesday after the apparel retailer reported holiday-quarter numbers that were far better than expected. Management also delivered a far above-consensus guide for fiscal 2019. Investors cheered the beat-and-raise report. ANF stock rallied more than 20%.
This rally continues what has been a historic, multi-quarter rebound in ANF stock from retail-apocalypse lows. Back in mid-2017, when retail apocalypse fears were at all-time highs and many investors feared that Abercrombie & Fitch was heading for the retail graveyard, ANF stock was under $10. After this most recent earnings pop, ANF stock trades north of $25, up more than 150% in less than two years.
Obviously, things are dramatically improving at Abercrombie & Fitch to warrant the huge rally in ANF stock. Top-line growth is improving. Margins are stabilizing. Bottom-line growth is coming back into the picture.
But the question now has nothing to do with whether or not things are improving. They unequivocally are. Instead, the question now centers on how much higher ANF stock can go so long as things continue to improve.
The blunt answer is not much higher. Management is making all the right moves to maximize medium- to long-term operational performance. Yet, upside from all those right moves is fully priced in today. By my numbers, ANF stock is already trading near a reasonable fiscal 2019 price target, and fiscal 2018 just ended.
As such, upside over the next twelve months in ANF stock is limited by an already full valuation. Investors shouldn’t chase the rally. But this stock will likely dip in a big way over the next few months. If it does, that could be a buying opportunity.
Abercrombie Is Back, & Doing Everything Right
By now, we all know that retail apocalypse fears that dominated the retail landscape in the mid-2010’s were way overblown.
In reality, e-commerce burst onto the scene, and quickly stole share from traditional retailers. But as it turns out, consumers still like to go to malls and buy stuff in-store. They also don’t like to do all their online shopping on one site. As such, as traditional retailers adapted over the past several years through store renovations and enhanced omni-channel operations, consumers returned to those traditional retailers. Consequently, sales and margins among traditional retailers have broadly stabilized over the past several years.
Abercrombie & Fitches serves as the quintessential example of this stabilizing dynamic. A few years back, comparable sales growth was in the deep red. Gross margins were dropping. Profits were being wiped out. It seemed like death was just around the corner.
Then, things started to improve in 2017. Abercrombie committed capital to renovating stores, while simultaneously rationalizing the real estate footprint through closing under-performing stores. They also doubled down on digital store investments, and more aggressively rolled out omni-channel sales capabilities. They tapped into Big Data, and started employing data-driven practices to improve customer loyalty.
All these initiatives brought consumers back to the ANF brand, both in-store and online. Comparable sales growth has since improved, and is now running off at a multi-year high on a two year stack basis. Gross margins have since rebounded, and are expected to keep improving for the foreseeable future. Expense rates are dropping. Profit growth has come roaring back.
Abercrombie is making all the right moves to ensure that this new era growth lasts for the foreseeable future. Namely, the company is still rationalizing the store base, renovating stores, improving omni-channel sales capabilities, and leveraging data to improve customer engagement. Thus, so long as the global consumer remains broadly healthy, Abercrombie & Fitch should continue to report solid numbers.
The Valuation Is Already Full
Unfortunately, solid numbers won’t cut it for ANF stock at current levels.
ANF stock currently trades hands north of $25. Fiscal 2019 EPS estimates will likely shake out around $1.30. Thus, ANF stock is now trading at over 19x forward earnings. That’s above the market average multiple of 16. It’s also above the retail apparel average multiple of 17. As such, ANF stock is trading at an above average valuation.
But growth going forward likely won’t be above average. At best, we are talking about low single-digit top-line growth coupled with some gross margin expansion and expense rate stabilization. Realistically, I think that combination will drive EPS towards $2.30 by fiscal 2025.
Based on a market average 16 forward multiple that implies a fiscal 2024 price target for ANF stock of nearly $37. Discounted back by 7% per year (3 points below by my normal 10% discount rate to account for the yield), that equates to a fiscal 2019 price target of just over $26.
That is roughly where ANF stock trades today, implying limited upside over the next twelve months.
Bottom Line on ANF Stock
Abercrombie & Fitch has staged a remarkable and impressive comeback since mid-2017. But fundamentals imply that it’s time for this 150%-plus rally in ANF stock to take a break. If the stock retreats from here in a meaningful way, that could be an opportunity to buy. But chasing here isn’t the best move.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
