Monday, March 1, 2010

While things are rough at Abercrombie, I'm not sure the stock rates a SELL...(ANF)



Abercrombie & Fitch(ANF) shares are up a bit today, despite a downgrade from Brean Murray analyst Eric Beder from HOLD to SELL. Their price target of $29 would imply 22% downside from current levels. They were only upgraded from sell to hold a few weeks ago...

The analyst thinks that Abercrombie's recent outperformance (versus both the industry and the broad market) leave the shares ahead of themselves. They think ANF's US operations are becoming more broken by the day, as they have to resort to discounting higher end fashion items to drive "any semblance of traffic" to the stores. They think a turnaround is further off than investors appreciate.

I've long been of the opinion that Abercrombie is wrong in its attempts to "protect the brand" by way of refusing to compete on price - or at least the extent of its attempts. The company thinks this will serve them in the long run, because once you give ground in the battle with your own customers on price, you can't get it back (as a side note, maybe you shouldn't be in battles with your customers anyway...?).

CEO Mike Jeffries echoed this strategy in their most recent earnings release:

"Having managed through a very difficult retail environment in 2009 with a long-term mindset of protecting our brands, we look forward to 2010 as we intend to grow the business internationally and improve the profitability of the domestic business."

Going forward, the company is acknowledging what others have prodded them to understand over the years...Their brand is not strong enough to keep consumers interested in paying double the price for "not double" the quality. Don't get me wrong, Abercrombie's quality is marvelous. But the gap between their product quality is narrowing much more quickly than the price gap, which is why consumers are losing any sense of brand loyalty here. The quote above regarding a "long-term mindset" about the brands is clearly frustrating investors and Wall Street, as exemplified by this recent conference call exchange:

Liz Dunn - Thomas Weisel
Regarding near term operating margins, I’m always a little bit weary when I hear a company give a longer term target but they can’t provide nearer term goals. Is there anything nearer term that you can point to, maybe what operating margins will look like over the next couple of years?
Jonathan Ramsden, CFO
What we said earlier on was that we expect directionally margins to improve in 2010 versus 2009 and obviously when we say that we’re talking about ’09 excluding all the one timers. Then we have the long term objective we’ve spoken to. I think there are a few different factors that could influence the margins this year including where we get to from a costing standpoint within this year. I think it also goes back to the point I just made, we’re executing a long term strategy and the next couple of quarters it’s frankly less important to us than figuring out that we’re on a path that gets us where we want to be over the next two to three years.

In terms of a SELL rating, I think the opportunity has been missed. Shares are at less than half their five year highs, and if this management doesn't figure out how to regain some semblance of previous years' profits, they will be kicked out and someone else will do it. I certainly buy the bear arguments against Abercrombie, but I think a SELL rating at these levels has less chance of being right than a BUY rating.
(In the charts below, the analysis is based on whole company results, so will not match up with a brand by brand analysis.)


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