Abercrombie & Fitch has strong financial fundamentals and underlying brands, but negative consumer perception and low margins may prevent the stock from reaching its full potential; I forecast the stock price of $45 over an 18 month period. Abercrombie & Fitch Co. (NYSE: ANF), founded in 1892 and headquartered near Columbus, Ohio, is a global omnichannel specialty apparel retailer for women, men and children that offers consumers five distinct brands. The company operates approximately 730 stores in North America, Europe, Asia and the Middle East and distributes its products in more than 110 countries. The company is supported by multiple brands, but two key brand segments make up the bulk of sales; Hollister, a young adult lifestyle brand, and Abercrombie, a casual luxury brand. ANF reported $3.7 billion sales in 2021 and plan to continue growing in 2022, fueled by Hollister, which was recently named Top 5 brands for teens; this report presents a bull case for the company, while also acknowledging their past discriminatory practices, given that they have come to light again in a new Netflix documentary.
As COVID delayed ANF’s momentum plans as governments closed malls and retail stores, a key positive emerged and has continued to this day: a strong online presence. . The company increased its online revenue to $1.7 billion last year, or 47% of the sales mix, from 28% in fiscal 2018. ANF also strengthened its in-store pickup model to support its online growth: 90% of its global store base has digital shopping/in-store pickup capabilities. The company has two key brands that make up its sales mix; Hollister (58%) and Abercrombie (42%). The company achieved strong growth in 2021, fueled by a 25% increase in U.S. revenue to $2.7 billion. ANF has a geographical distribution of sales that focuses on the United States, with 71% of last year’s sales there. The company has always had a stable capital structure, with only 50 million shares outstanding. However, to stay afloat during COVID-19, ANF has taken on long-term debt at a rate of 8.75%, which will reduce its cash position until maturity in July 2025.
ANF is part of the fast fashion industry in apparel and counts among its main competitors American Eagle (AEO), Guess (GES), Urban Outfitters (URBN) and The Gap (GPS). The global fast fashion market is expected to grow at a CAGR of 7%, representing $40 billion in sales by 2025. Benchmarking its competitors, ANF holds two key advantages. The first is their high gross margin; the company cultivated a unique American brand, while reducing the cost of materials, which helped its margin to remain high. Even throughout consumer preference cycles, their gross margin has historically exceeded that of their peers, going back several years. Given volatile cycles and global supply chain challenges, their gross margins of over 60% should support their profit targets.
The second benefit is their digital sales business. ANF has increased its online share to almost half of its sales mix and sells the majority of its inventory through its online store. The company reduced its store base, coinciding with the return to revenue growth in 2017. This agility enabled a strong rebound in fiscal 2021 – the company generated EPS of $4.41 after losing $1.82 the previous year.
When analyzing a fast fashion apparel brand, there are a few key risks that are inherent and cannot be fully mitigated. At the macro level, there is a risk related to ANF’s inability to anticipate and adapt to changing consumer preferences. Additionally, there is a risk associated with pricing pressure given high inflation and global supply chain issues. Another global risk is the potential impact regarding future store closures due to COVID-19. Although the company has a balanced sales mix, store presence is still important for customer service and retention. Regarding the company itself, in the recent past there have been allegations of improper hiring practices, including hiring based on appearance. Netflix released a documentary on April 19 called “White Hot: THE RISE & FALL OF ABERCROMBIE & FITCH”. This reminded consumers of discriminatory employment and marketing practices. Several employees detailed instances of firing models based on perceived ugliness and campaigns supporting perceived sexual harassment and a line from 2009 proclaimed ‘Show the twins’ above a photo of a young woman with her blouse open to two men. This risk is significant because many new viewers, especially teenagers who purchase their product, are unaware of ANF’s past and may turn away from the brand in the future. Although the company changed management several years ago, it is not known if its internal culture has changed. Additionally, Netflix’s document may encourage other employees to speak out about other previously unknown inappropriate behavior. I await feedback from the management team on this recent publication on the upcoming earnings call. The company also only has two key brands, so the risk of concentration of a brand going down can be a concern.
The model shows the material upside down
If ANF achieves growth even close to its expected growth, its share price is likely to rebound. Although locking in a senior rating at 8.75% stings in hindsight, the company’s net cash position of over $600 million provides ample opportunity to pay it off early or even refinance soon if it chooses. Given their strong performance in 2021, I don’t expect the cost of debt to rise dramatically above 7.5% if they try to adjust their leverage in this environment.
I predict a continued value of around $2 billion, given a mixed 3.25% revenue increase for five years with weaker growth next year before accelerating in 2023 as issues of the supply chain are diminishing. The company expects revenue growth of 2-4% next year, and I expect growth at the lower end of the range. I see SG&A spend slowly dropping from 53% to 52% as a percentage of revenue over a 5-year period as digital sales synergies continue to pay off. I see raw materials jumping this year given supply constraints, before returning to historical averages in 2023. there aren’t too many material differences in the 2018 and 2019 numbers. I expect the company to hold the debt to maturity without refinancing, which explains the low cash flow in 2025. As the margin remains stable while as growth ensues over the 5-year term, a stock price of $48 (see below) can be sustained with strong fundamentals.
ANF continues to operate effectively and has shown resilience during the pandemic. The stock discount today, closing near ~$35, offers investors an opportunity over the next 18 months. I expect the stock price to reach $45 as the company invests and prospers through its digital offerings. The company saw strong growth from 2017 to 2019 and rebounded with strong earnings in 2021. While the company is undervalued and the model supports $48, I’m taking a cautious cut given the weak apparel industry profit margins, brand perception risk, and historically weak institutional investor sentiment.