Markets

Abercrombie & Fitch: Upscale Prospects

The best-priced item at this fashionable retailer could be its stock.

"Did you see the awesome sale at Abercrombie & Fitch?" That's something you're not likely to hear from a high schooler any time soon. The upscale retailer has built its business on the notion that teenagers will pay premium prices for its jeans, T-shirts and button-downs, so bargains are scarce. But investors don't necessarily have to pay up for Abercrombie's shares. In fact, says analyst Stacy Pak of Prudential Equity Group, the stock looks cheap when viewed against the company's strong earnings prospects and when compared with the shares of its competitors. For that reason, she upgraded Abercrombie's stock (symbol ANF) from neutral to overweight on January 16.

Pak's position that the stock is a bargain comes despite a 59% advance since last July. The shares, which finished the day at $78.67, up 0.7%, trades at 15 times the average analyst earnings estimate of $5.27 per share for the fiscal year that ends January 2008. (Pak thinks the company can earn at least $5.38 per share.) In contrast, American Eagle (AEOS; $34.34) sports a price-earnings ratio of 18, and Aeropostale (ARO; $36.10) a P/E of 17. Pak says that the average specialty retailer trades at 19 times estimated profits.

Pak points to a number of developments that should help keep Abercrombie humming this year -- and exceeding investor expectations. In addition to better managing inventories, the company is investing in new technology systems that are designed to boost profit margins and help the company better meet demand from specific stores. Matching inventory with customer demand is important for maximizing full-price sales -- which ultimately helps maintain brand cachet, a critical aspect of Abercrombie's success. Responding successfully to teenagers' fickle tastes is also essential, and Pak notes that the retailer's new design center is pushing clothes from the drawing board to the racks more quickly than ever.

In addition to its Abercrombie & Fitch stores, the company operates stores under the Hollister Co., Ruehl and abercrombie brands. The company's long-term earnings growth will in part depend on its ability to develop these new brands, says J. Susan Ferrara, an analyst at Value Line Investment Survey. The Hollister chain should be a particularly good source of growth, she says. The 380-store chain already has more locations than the company's namesake brand. Abercrombie also continues to experiment with its 14-store Ruehl brand, which targets the post-collegiate set, and it is developing a fifth concept, which is likely to appear early in 2008. Overseas expansion could fuel additional growth. The company has six shops in Canada and plans to open its first store in Europe this year.

Selling trendy, premium-priced clothes to young people is hardly a surefire business, but Pak figures that if all goes well for Abercrombie, its stock can reach $89 within the next 12 to 18 months.

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