We’ve seen an incredible run for the retail sector (XRT) since the start of the year, with the ETF outperforming the S&P-500 (SPY), up more than 49% at the end of the year. approaching the second half of 2021. One of the top performers was Abercrombie & Fitch (ANF), with the company’s store count streamlining and digital strength driving strong demand for the stock. Notably, the recent partnership with Charli & Dixie D’Amelio should provide additional tailwind among its Gen Z clientele. , the stock looks fairly valued heading into the second quarter earnings season. Thus, a strong second quarter earnings reaction should provide an opportunity for profit taking.
Abercrombie & Fitch (“Abercrombie” released its first quarter results in late May with a massive beat in earnings per share and revenue, with quarterly EPS of $0.67 and revenue of around 781 million, a more than 11% overrun on estimates.While many retailers performed strongly in the first quarter, such as American Eagle (AEO), Abercrombie & Fitch was one of the leaders, posting growth revenue of 6% from Q1 2019 levels and massive digital gains, with company-wide digital sales up 81% over two Notably, mid-single-digit revenue growth was achieved despite operating at only 92% capacity, with shutdowns in EMEA related to COVID-19. Let’s take a closer look at the results below:
(Source: Company Documents, Author’s Table)
As shown in the chart above, the first quarter was a strong quarter for Abercrombie, with revenue growing 61% year-over-year, beating COVID-19 restrictions, and growing 6 % compared to the first quarter of 2019 ($734.0 million). Both of the company’s brands performed well, with Abercrombie leading the way over two years with net sales growth of 11% (~$339m vs. ~$305m) and Hollister up 3%. That the company managed to increase net sales despite losing more than 1.3 million gross square feet in its store base is a testament to its digital strategy, with digital sales up 81% year over year and 45% over one year. year. At the end of the quarter, Abercrombie had 674 of 731 stores open (92%), with the bulk of store closures in Western Europe.
(Source: company website)
One of the most exciting developments after the end of the quarter was the partnership with Charli & Dixie D’Amelio, two TikTok stars who arrive at #1 and #10 for most subscribers on the app. The two stars amassed around 170 million subscribers in June and will be partnering with Abercrombie on a new brand called “Social Tourism” under an exclusive multi-year apparel agreement. Abercrombie noted that Charli & Dixie are involved in every aspect of social tourism, including product selection, design, branding, positioning and marketing.
Abercrombie’s goal is to increase eyeballs in the Gen Z market, with plans to roll out new products every month, and each collection will have limited-edition items. This is similar to the partnerships Crocs (CROX) has had with stars like Post Malone and Justin Bieber which have seen incredible success. Assuming the partnership is successful, it could provide a major boost to sales, with investors set to get a taste of how the launch fared in Q2 earnings this summer (August 25).
(Source: Company Documents, Author’s Table)
As previously reported, digital growth has been exceptional, with digital sales growing from 45% last year to 52% of total sales. This helped Abercrombie grow US sales by 18% in the US market despite pre-COVID-19 levels, despite a significant decrease in square footage. Notably, first quarter operating profit reached the best levels in over a decade (2008) and gross margins climbed to 63.4%, one of the best numbers in the last five years. This is 290 basis points above Q1 2019 levels (60.5%) and helped by strong multi-year margins for Abercrombie Women’s and Hollister Girls & Kids.
(Source: Company presentation)
The only real weakness in the quarter was international business, with EMEA up just 41% year-over-year, APAC up 42% and Other up 29%. However, exceptional results in the company’s largest market (US) offset the weakness with a 72% increase over 2020 levels ($553.8 million vs. $322.9 million) . The good news is that as vaccination rates increase in these regions, we should see a tailwind in the second half of the year, with the US market likely to be buoyed by the Charlie & Dixie partnership. Given the success so far of net sales growth despite lower square footage, Abercrombie has the potential to continue to downsize its store count in underperforming stores, with up to 50% of leases at renew over the next two years.
(Source: YCharts.com, author’s chart)
Given mid-single-digit sales growth and a solid increase in gross margins, Abercrombie expects massive growth in annual earnings per share, with estimates for fiscal 2021 currently standing at $3.3. As shown in the chart below, this would result in a breakout year for earnings, with annual EPS expected to hit a new multi-year high above the previous high of $1.54 in fiscal 2014. Earnings breakouts are bullish developments, especially when earnings momentum in the following year is expected to confirm the breakout. In Abercrombie’s case, annual EPS is expected to fall in fiscal 2022 and 2023 based on current projections, but this is still a very impressive recovery, especially as operating capacity n is still not back to normal in this post-COVID-19 environment.
(Source: YCharts.com, author’s chart)So, is stock a buy here?
While Abercrombie’s numerical earnings are impressive and the company should have a strong H2 with a more normalized back-to-school season and a huge early-stage partnership, Abercrombie looks almost fully valued at current levels. Indeed, the stock is trading at the upper end of its historical enterprise value range relative to sales, with the stock trading in a range of 0.20x to 0.55x sales over the past few years. Currently, Abercrombie sits at 0.66x sales, which is justified given the impressive margin expansion and what should be a strong Q2 and Q3. However, while the slight premium is warranted, there is no significant safety margin for new investors looking to get involved here above $47.00 per share.
(Source: YCharts.com, author’s drawing)
Moving on to the technical picture, we can see that Abercrombie is heading into an overbought zone in the near term, with the stock up more than 375% in the previous 15 months. The last time the stock got this overbought was in April 2019 at $28.00 per share. Although the stock rose, the next new high was an opportunity to strengthen earnings. Obviously, history doesn’t repeat itself, but it can rhyme, suggesting that if Abercrombie can make a new high from here above $49.00, it would present a similar opportunity to book profits in strength.
Abercrombie is set for a revenue breakout year and is expected to have a booming back-to-school season, with schools across North America set to return to a more normal schedule in the fall. However, Abercrombie appears to have priced in some of that upside, with the stock currently trading at more than 14x fiscal 2022 earnings estimates and nearly 0.7x sales. It’s not an expensive valuation, but it’s not cheap relative to the stock’s historic range, suggesting that the upside may be limited heading into the second quarter results, barring a an explosive report. Given the less favorable reward/risk ratio, I believe there are better opportunities elsewhere in the market, and I would view any rally above $49.25 as an opportunity to book some profits.