After I poked at Abercrombie & Fitch (ANF) in my article on Snapchat–using it as my example of permanent capital destruction following a period of high investor sentiment–I wanted to make sure that I wasn’t take an underserved shot at the company so I reviewed it for the first time in a few years.
Usually, when a stock falls from the $80 to $15 range and is still earnings a profit, the fair follow-up question is: “Has this stock fallen so far that it is now a value pick?”
But I don’t that type of thinking applies here.
Abercrombie is only earning between $0.70 and $0.90 per share in profits (the reason for the wide variance is because retailers are heavily reliant on end-of-year as November and December sales alone are about equal to the other ten months combined.)
It is paying out $0.80 per share in dividends. This means that the company is either paying out more than it is earning in profits, all that it is earning in profits, or nearly all that it is earning in profits. Whether you get the high end or the low end of results, there aren’t any retained earnings to give Abercrombie the wiggle room to experiment with other options.
The problem is that profit margins have been crushed, and there is no growth in the amount of people that want to buy Abercrombie clothes. For the past decade, the revenues have been in the $3 billion range. It had a low of $2.9 billion in 2009, and a high of $4.5 billion in 2012. It has a ten-year average of $3.7 billion in annual revenues and current revenues of $3.4 billion.
While revenues have remained generally static, the profit margins have crumbled. Those 40% operating margins have fallen to the 8-10% range for the past three years. As a consequence, those $300-400 million profits of the early 2000s have fallen to $50 million in recent years.
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.