Abercrombie’s Q2 2024 Was Great; The Future Is More Muted, But The Stock Is Now A Buy (Upgrade)
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Summary:
- Abercrombie & Fitch’s 2Q24 results were very good, with improved guidance. However the market dropped the stock. This is normal for a company with high expectations.
- Although Abercrombie’s growth will be lower in the future, given that its biggest drivers of growth, AUR and traffic, cannot grow forever, the company still has growth opportunities.
- Despite this, the stock price discounts that the company will only grow 4.5% or even less going forward. In my opinion, these levels are easily reachable by the company.
- The company’s fashion cycle risk is low, given that it focuses on basics and trend following.
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Abercrombie & Fitch’s (NYSE:ANF) 2Q24 results were really good, yet the market dropped the price by 17%, signaling lofty expectations can thump on good company development.
The results do not provide a lot of information about the future, given ANF management’s discrete approach to earning calls, and conservative guidance. However, the stock is down 30% since my last article, and I believe this merits a revision of the thesis.
Today, the market values ANF at a multiple of 13x or, conversely, at a current yield of 7.5%. In my opinion, a company like ANF requires a return of at least 12%, which implies growth of 4.5%. I believe the company can very well post this type of growth, given that it has not yet considered fleet expansion in the US or abroad and that its fashion cycle risk is moderate, given that its style consists mostly of classic basics and that the company is not a trend setter or a category maker. For that reason, I believe ANF is now a Buy.
Impressive results
ANF has posted incredible growth for two years already, and 2Q24 was no different. The numbers have been greatly covered in other articles published after earnings, so here I will only provide a summary.
The company posted top-line growth of 21% (18% comparable given a week shift from 3Q into 2Q). This growth was well spread across both brands (Abercrombie up 21% comparable, on top of 26% growth last year; and Hollister up 15% comparable), and regions (Americas up 18%, EMEA 17%, and APAC 21%). Management commented during the call that the performance has been well spread across apparel categories, too.
Such tremendous growth, fueled by store closings (the company opened 18 stores and closed 26 YTD), came with significant cost leverage. This led to operating margins reaching 15%, putting Abercrombie at the top of apparel retailers.
Little info on business developments: ANF’s management did not provide much information on their plans or specific business developments during the calls. They provided some detail about styles that are working well, but not much more. For example, there was not a lot of mention of advertising expenditures or where the campaigns are directed, despite ANF’s well-known influencer-based advertising system.
Updated guidance: ANF has generally beaten guidance, which by design or not, has tended to be excessively conservative for the past two years. This was not the exception, and the company increased top-line expectations and margins. Revenue is expected to be 12/13% above FY23 (or about $4.8 billion). This still embeds 2H24 sales falling close to $90 million (mostly in 4Q24), because of calendar shifts (one week moving from 3Q to 2Q this quarter and a missing week in 4Q24). Operating margins were increased to 14/15% from the previous 14%.
Prices down: As commented in other articles, it was ironic to see the company performing so well, with the stock losing 17% in a day. This serves as a reminder to readers that investing in growth companies with high multiples and super optimistic expectations can be a risky game. Even when the optimistic outlook materializes, the stock price may suffer from a reaccomodation of multiples.
ANF valuation
Given the lack of operational detail from the call and the fact that earnings were covered in other articles, I would not have written the article if ANF’s price had remained close to the last price at which I covered the stock (about $190). However, considering yesterday’s fall, the stock is down 35%, so a revaluation is merited.
Growth prospects still muted: As mentioned in my previous article, most of ANF’s growth has come from higher AURs, mixed with more traffic. It also has come from lower promotional activity, as the company has managed its inventories better. These engines for growth will not be able to push the company so much in the future, and the future probably implies lower growth.
During the call, management commented on the possibility of expanding the fleet in the US and, more importantly, abroad, but so far, plans for this have not materialized (the company only expects to grow stores by a net 2.5% this year).
Another engine for growth, now in the bottom line, has been operating leverage and commodity prices. Both of these sources will also be exhausted starting in 2H24. On the leverage side, the company will probably not be able to post the same level of same-store growth. On the cost side, the improvement in cotton and freight prices from 2022 and 2023 has been mostly anniversaried. The company did not guide for further improvements in this area.
Fashion risks not elevated: When a fashion company has grown so much in so little time, my main concern is a reversal of fashion risks. However, I do not believe those risks are significant for ANF because the brand is a fast fashion retailer (that means a trend follower more than a setter) with a style that focuses on basics and a relatively sober style. This means customers look at the company to build a wardrobe rather than get the latest trendy pieces. If they look for trendy pieces, ANF can offer that too, only later. This is what the company calls ‘chase mode,’ meaning going after what is hot.
Yield and return: Today, ANF trades at a market cap of about $7.3 billion, or an EV of $6.5 billion, considering net cash assets. Against these, the company expects to post about $650 million in operating income, or $487 million in NOPAT (at a 25% tax rate).
This implies an EV/NOPAT multiple of 13.2x or a yield of 7.5%. In my opinion, a quality retailer like ANF, with a solid balance sheet, should offer at least a 12% yield. This implies that the company should post at least 4.5% growth over time at the current price.
I believe this level of growth is not excessive for a company with ANF’s characteristics, which have positioned it as a desirable fast-fashion retailer. True, the company’s growth rates will not be as high as in the past. However, the company still has several avenues to post mid-single-digit growth: store expansion at constant margins, licensing abroad, and slow, economy-type AUR growth.
For that reason, I believe ANF has become an opportunity at these prices, and I change my rating to Buy. At lower prices, it will become an even better opportunity.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in ANF over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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