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Abercrombie Pinned to Neutral

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We retain our long-term Neutral recommendation on apparel chain store operator, Abercrombie & Fitch Company (ANF - Free Report) . The company also retains a Zacks #3 Rank, which translates into a short-term Hold rating.

Our balanced approach on Abercrombie mainly relates to its aggressive move to close underperforming stores while expanding its global operations, offset in part by the company’s not so good earnings results. Further, the company continues to improve cash flows while maintaining a healthy balance sheet, which bodes well for its future growth.

In the fourth quarter of 2011, the company registered a 16% growth in the top-line but witnessed a fall of 18.8% in the bottom-line, on account of contracting margins. However, the company’s reported sales and earnings per share were in line with the Zacks Consensus Estimate. Sluggish average unit revenues (AURs) and higher average unit costs (AUC) in the quarter exerted considerable pressure on margins.

Nevertheless, the company’s optimism on margins remain intact as it expects poor sales and AUR trends for 2012 to be offset in large part by the reversing of AUC trends in the later half of 2012. Moreover, over the longer term, the company targets 15% growth in sales and over 15% in earnings per share.

Additionally, the company has a very healthy and debt-free balance sheet with cash and cash equivalents of $583.5 million at the end of fiscal 2011. This offers Abercrombie the flexibility to drive future growth.

Another positive driver for the company is its ongoing efforts to expand international operations in the face of economic challenges. The company is winding up its unprofitable U.S. locations and accelerating growth at its Abercrombie Kids and Hollister store concepts. Highlighting the company’s growth plan is to increase its presence in international markets as a means to drive top-line growth.

During fiscal 2011, the company opened 47 new international stores while it closed 71 stores in the U.S. In fiscal 2012, Abercrombie plans to open five Abercrombie & Fitch stores in flagship locations including Hamburg, Hong Kong, Munich, Dublin and Amsterdam as well as an abercrombie kids store in London. The Munich and Amsterdam locations will also house new abercrombie kids store. Moreover, the company plans open about 40 international Hollister stores in fiscal 2012.

On the flip side, the company’s over-dependence on outside suppliers, intense competition from discount retailers and seasonality of business may undermine its future operating performance.

Abercrombie operates in a highly fragmented market and competes with national as well as regional players. Besides competing with larger retailer like Gap Inc. (GPS - Free Report) , the company also competes with value-priced specialty retailers such as Aeropostale Inc. .

Though cognizant of the rising retail market, we are also conscious of the steep competition in this space along with rising commodity prices.

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