Last month, I wrote an article critical of Abercrombie & Fitch (ANF) stock. I said, in part:
“Theoretically, the premise ought to be pretty simple: Abercrombie yields 5%, the historical performance of the S&P 500 is 10%, so all you need is the maintenance of the dividend and 5.1% earnings per share growth to beat the market.
But I am unpersuaded. The current $0.80 annual dividend payout takes up all of the earnings, and perhaps even more so, and this is fertile soil for a ripe dividend cut. And secondly, there is no five-year comparison period in the past ten years in which Abercrombie shareholders can point to growing earnings. This means that you can’t even rely upon the current $0.70 to $0.90 base to serve as a low point. Things could get worse.
And even right now, the P/E ratio of 19x earnings isn’t that attractive of an entry point. When you include the deteriorating margins and profits, the stagnant revenue, and the dividend that has no wiggle room, it looks even worse. There are even odds that this dividend will be cut, and there are even odds that profits won’t improve in the next five years. Because earnings consistently deteriorate, rather than stagnate, there is no rational basis to conclude that this stock qualifies as a value investment. Once your brand’s pricing power is gone, it’s hard as heck to get it back.”
Today, my thesis received some (at least short-term) vindication with news that Abercrombie’s quarterly earnings dramatically missed expectations and only came in at $0.02 per share. Revenues are down 6.5% compared to this point last year. Same store traffic is down 6%. It made $1.20 in profit during the Christmas season last year–it will need to approximate that figure this year otherwise it will have to make a choice between cutting the dividend and compromising the balance sheet.
As a result of these news items, the stock fell 14% today.
This is what I meant last month when I said you can’t focus on the 5% dividend and conclude that Abercrombie stock offers a good value. When the “E” in P/E has a high likelihood of declining, you can’t rely on traditional value metrics because you have to adjust for the future deterioration of the business model.
If you are someone that likes to make investments that can be held for 25+ years, there is no way Abercrombie stock should show up anywhere on your list. The earnings quality is so low that it is automatically disqualified.
It is now more difficult for me to appraise Abercrombie as a medium-term value investment. The question “Does Abercrombie at $14 per share offer the prospect of fair five-year returns?” has been moved to my too hard pile. The Hollister brand is holding up well in Europe. If you look at today’s earnings figures, it is all deterioration at Abercrombie that is dragging the corporation down. The Abercrombie brand’s revenues were down 14%; Hollister’s revenues remained flat. It is entirely possible that a Hollister spinoff at some point could create so much future value that it would justify an investment.
But my view is that it is going to be easier to make money elsewhere. The company’s strategy is now about scaling back discount promotions, and I don’t Abercrombie is a premium brand capable of pulling this off. It seems that it is in the process of making the same mistake that Famous Barr made a few years ago. People love discounts, and there is nothing special about Abercrombie anymore that warrants paying up. As a result, you keep seeing this gradual attrition in the earnings. Plus, it is heavily reliant on the mall business model, which is in long-term secular decline. High prices + malls + no brand power sounds like a set-up to an investor’s horror movie.