Abercrombie & Fitch: Investors Simply Don’t Trust The Retailer
2022.06.22 15:56
At its Investor Day last week, Abercrombie & Fitch Company (NYSE:ANF) detailed its financial targets for fiscal 2025 (ending January 2026). A&F expects revenue of $4.1 billion to $4.3 billion, at an operating margin of 8% or better.
At the low end of sales, and exactly 8% margin, A&F would generate $328 million in operating income. At an effective tax rate of 28.5%—the FY19 level—net profit would come in at $234 million (Abercrombie & Fitch does have $308 million in outstanding debt, from bonds issued in July 2020 to create a margin of safety during the novel coronavirus pandemic. Those bonds mature in 2025, and presumably, A&F will pay them off then, eliminating interest expense).
$234 million in net profit, against a current share count of 50.447 million, suggests earnings per share of $4.65. It’s even possible that A&F’s share count will be lower: the company repurchased a whopping 10.2 million shares in FY21, and another 3.7 million during its fiscal first quarter.
In five quarters, the ANF share count has declined by nearly 22%. Over those five quarters, A&F paid an average of over $35 per share, against the current ANF stock price under $20. At these lower prices, the company presumably can buy back even more stock—and, based on its FY25 model, get that year’s earnings per share well past $5.
Again, ANF now trades under $20. That in turn suggests that the stock trades at less than 4x FY25 earnings if management’s targets are hit.
Of course, that’s precisely the point. ANF trades at less than 4x management’s target earnings not because the market isn’t paying attention, but because it is. The market simply doesn’t trust that guidance—for a number of good reasons.
Fool Me Once, Shame On You. Fool Me Seven Times…
One big reason for skepticism comes from simple history. We’ve seen this story before, in which A&F seems like it’s finally turned the corner. Every time to this point, ANF stock has disappointed and eventually made a lower low:
ANF Monthly
At the beginning of the last decade, it was the ‘California cool’ brand Hollister, which posted same-store sales growth of 6% in FY10 and 8% in FY11, two years in which the US economy was still recovering slowly from the financial crisis. Hollister stalled out the following year.
The namesake Abercrombie & Fitch brand has shown signs of life on occasion, but hasn’t been able to drive consistent growth. All told, A&F generated $4.5 billion in sales in FY12—and about 20% less seven years later.
The retail model can’t work without growth. A&F is no exception. Operating margins in FY12 were over 8%; by FY19, they were below 2.5%, even on an adjusted basis.
Right now, this time indeed doesn’t look different. If it isn’t, ANF stock has further to fall: shares are still up 12% from where they traded at the beginning of 2020.
The Mall Problem
To be fair, A&F isn’t alone in struggling. Mall retailers of all kinds, including the likes of Gap (NYSE:GPS) and Victoria’s Secret (NYSE:VSCO), have seen sales and margin pressure for years.
The ‘Three As’ of teen retailing haven’t done any better. American Eagle Outfitters (NYSE:AEO) has built a valuable brand in Aerie, yet its stock still is down 39% over the past decade. (ANF has performed one percentage point better.) Aeropostale filed for bankruptcy in 2016.
But this, too, is precisely the point. The core of the Abercrombie & Fitch business, whether under its namesake banner or through Hollister, is selling clothes to teens, mostly in malls. And that just isn’t a very good business anymore.
It’s worth remembering (and I do, since I was a teenager then) that young Americans used to pay the ‘Three As’ for the privilege of wearing their logos. It’s difficult to think of a better business model than that—but the logo business for A&F is all but gone at this point.
The reason ANF stock soared last year is that investors believed, for a moment, that it indeed was a good business again. Fundamentally, that seemed to be the case. Digital sales accounted for nearly half of the company’s total. Operating margins neared 10%—toward where they were during the company’s glory days. Adjusted EPS came in at $4.35.
But it’s become increasingly clear—for A&F and for other retailers as well—that what happened in 2021 simply was a perfect storm of stimulus checks, a booming economy, and lingering post-pandemic pressure on spending on travel and experiences.
In other words, last year looks like an outlier, not a reversal in trend. The plunge in retail stocks here in 2022—ANF is down 45% so far this year—is due in large part to investors coming to that realization.
The Q1 Miss
Clearly, Abercrombie & Fitch disagrees. The fiscal 2025 targets to some extent do incorporate the idea that fiscal 2021 results came in an enormously beneficial environment: the company still sees operating margins declining in the range of 150 basis points between FY21 and FY25.
But those targets also countenance quite a bit of improvement from pre-pandemic levels, with revenue up roughly 16% (at the midpoint of the target range) and operating margins more than tripling.
Management could be right in projecting that kind of improvement. But one problem in believing the targets for three years from now is that they were issued three weeks after management whiffed badly on this year.
After Q1, the company cut its full-year sales outlook by two percentage points. What’s more worrisome is that A&F cut its operating margin outlook by two percentage points as well, from 7-8% to 5-6%.
Management largely attributed the reductions to inflation, which raised costs for both the company and its consumers. Inflationary pressures no doubt are real. But the sharp reduction in guidance this year—which implies a nearly one-third reduction in forecast EPS—simply highlights how difficult it is for management to accurately forecast a retail business. Operating margins are so thin that modest changes have big impacts on profits—and the stock price.
Certainly, the fact that management erred in its guidance for FY22 does not, on its own, mean the FY25 guidance is untrustworthy. But it does provide a reminder that, in general, skepticism toward long-term targets from management should be the default.
Add in the other reasons for caution, and it’s no wonder that ANF stock has reversed. It’s going to take quite a bit of time for the company to regain investor trust—if it can do so at all.
Disclaimer:
