During the past two decades, management teams at virtually every
major U.S. company have identified plans to move into foreign
markets. Whereas in terms of population and purchasing power, the
offers the same opportunity as the U.S. market,
such as Brazil, China, Russia, and Indonesia are becoming the third
major economic block in the world.
Indeed, international sales growth has been the biggest top-line
driver for hundreds -- if not thousands -- of U.S. companies in
recent years. Yet it cuts both ways. The companies with
considerable foreign exposure are smarting right now.
Ford Motor (NYSE:
, for example, are making huge profits domestically but losing
Perhaps no single company has been punished for its foreign
expansion as much as teen retailer
Abercrombie & Fitch (NYSE:
. Investors grew excited in recent years by the fact that the
company's 100 international stores, which represented just 10% of
the total store base, had come to represent about 20% of sales and
in fiscal (January) 2012. These stores were explosively popular
among teenagers -- especially in Europe. But right now, these teens
aren't spending a dime.
The effect on ANF's share price has been stunning.
I had been watching this stock's steady meltdown, but waited to
further research it until it looked like the selling frenzy had
abated. Early this week,
slipped briefly below $30 -- for the first time in three years --
and have started to attract buying interest. With the sellers
possibly flushed out, I took a fresh look at Abercrombie
& Fitch's current valuation and forward prospects.
And I like what I see.
How bad is it?
Management noted challenging sales trends when it released fiscal
first-quarter results in mid-May. Same-store sales in the United
States are likely to be slightly positive for the rest of the year,
while sales at foreign stores are likely to remain weak, perhaps
15% lower than a year ago.
Analysts had anticipated a tough outlook a few quarters ago and
sharply reduced their
forecasts this past winter. On the heels of fresh guidance, they
reduced earnings-per-share (
) estimates a bit more in the past 60 days. Analysts lowered their
fiscal (January) 2013 EPS estimates from about $3.55 to about
$3.45. The fiscal 2014 EPS outlook has fallen around 30 cents to
Why haven't forecasts fallen even more sharply? "The company has
secured better product costs beginning in 2Q12. This enabled
management to maintain F2012 EPS guidance even despite weaker
international sales," according to analysts at Merrill Lynch, who
rate shares a "buy" with a $54
(implying more than 75% upside).
Let's assume the worst isn't over, and Abercrombie ends up
earning about $3 a share in the current
and around $3.75 in fiscal 2014. Shares still look like a bargain
at around eight times my projected 2014 profits.
Not just cheap
It's not hard to find stocks with cheap forward multiples, but
rarely do they involve companies with outstanding track records.
While rivals such as
American Eagle Outfitters (NYSE:
typically post gross margins in the 30% to 40% range, ANF's gross
margins haven't dipped below 60% in a decade. This is a management
team that has a magic touch when it comes to merchandising, from
purchasing to promotional strategies.
Management never moves too quickly when it comes time to alter
the product mix. The retailer has historically been known for its
tops (shirts, sweat shirts, hoodies, etc.) but is steadily
expanding into denim (an American Eagle forte), yoga gear and other
niches. That's why management says same-store sales can keep moving
up at least modestly here in the United States, even as the
is slow. (The current European sales weakness implies a large
snapback in sales when that region recovers.)
Also, consider that Abercrombie & Fitch has poured a hefty
$2 billion into capital spending in the past seven years, which
should have led to a drain in
free cash flow
while growth was being pursued. Yet during that time, ANF has
generated $600 million in free cash flow. Now, with the global
store expansion largely complete, free cash flow should really take
off -- even if sales don't. Merrill Lynch sees free cash flow
rising from $150 million in the current fiscal year to more than
$300 million in fiscal 2014 and around $360 million in fiscal
Management has been returning cash to shareholders, buying back
$161 million in stock in the fiscal first quarter, and plans to
spend roughly $300 million more on further buybacks in the next few
quarters. This could boost annual EPS by around 15 cents. The
is decent, though based on projected
trends, it could double in size, even as Abercrombie pursues that
Risks to Consider:
The U.S. economy is growing at a modest pace right now, but if
we slip into
again, then this and other retailers might fall even further out of
Action to Take -->
Notably, this is the only one of three "A" retailers (along with
Aeropostale and American Eagle) trading at a single-digit forward
multiple. That's likely due to a challenging fourth quarter that
led management to underestimate the slowdown in demand in Europe.
Expectations have been reset to a more realistic level, and now it
is a matter of time before management restores its credibility.
"We believe as the company once again registers solid upside and
provides better visibility that the Street will reward ANF with a
multiple in line with their peers; we believe ultimately it should
receive a valuation at a premium to their peers," analysts at Brean
Murray say. This explains the firm's $65 price target, which
is more than 100% above current levels.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of F in one or more if its "real money" portfolios.