Abercrombie & Fitch Could Fit Your Portfolio
After an 8% drop in its stock price Wednesday, the short-term answer is clearly no. To understand why, it's worth looking at the earnings it reported -- and they were great except for one problem. For its quarter ending July 30, A&F reported $32 million in net income, 64% more than the year before. Its adjusted earnings of 37 cents a share beat expectations by a whopping 30 cents a share.
A&F's revenues also soared. They were up 23% to $916.8 million. U.S. sales rose12%, while international sales leaped 74%.
The problem for A&F was that it could not increase its prices as fast as its costs rose. This resulted in a 150 basis point (100 basis points = 1%) decline in its gross margin to 63.6%, driven primarily by an increase in average unit costs.
Did the market over-react? Here are three reasons to consider investing in A&F:
- Cheap stock. A&F's price to earnings to growth of 0.69 (where a PEG of 1.0 is considered fairly priced) means it is cheap. It currently has a P/E of 29.5 and is expected to grow earnings 43% to $4.69 in fiscal 2013.
- Good quarterly earnings. A&F has been able to meet or surpass analysts’ expectations in all of its last five earnings reports.
- A&F is out-earning its cost of capital. A&F is earning more than its cost of capital – and it’s improving. How so? It produced no EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In 2011, A&F's EVA momentum was 2%, based on 2010 revenue of $2.9 million in 2010 to $66 million in 2011, using a 10% weighted average cost of capital.
A&F looks like a good company and the recent plunge in its stock price has made it very inexpensive relative to its earnings growth. The big risk with this stock would be a further rise in costs -- but given the recent plunge in cotton prices from an all-time high of $2.27/pound in March 2011 to its most recent 93.5 cents/pound in July, the worst of that could be over.