Pitch for:

Abercrombie & Fitch Co.

(ANF) By the Consumer Goods Sector group: Ryan Sepassi, Ben Enowitz, Danielle Kolin, and Victoria Woods

ANF Summary
Sells fashionable clothing and accessories to a customer base age 14-30yrs Abercrombie & Fitch Co. has 5 brands: Abercrombie & Fitch, Hollister, abercrombie, RUEHL, and Gilly Hicks (underwear and lingerie). Most of ANFs products are sold through their brand-name stores, located in malls. Market Cap = 1.56B

Porters 5 Forces
Degree of Rivalry- moderate/high The teen fashion retail clothing industry is very competitive. However, ANF has a competitive advantage over other specialty retail clothing stories through its product differentiation. They have many customers who are loyal to their product and brands. Threat of Substitutes weak There are not many valid substitution threats to the retail clothing business. Although wholesale distributers like B.J.s may take a bit away from the retail clothing industry as a whole, those customers usually do not shop at ANF brand stores anyway.
Buyer Power - weak The buyers of ANF apparel are mainly individual consumers, since ANF sells their brands in their own stores. Therefore, the customers are weak since they are fragmented. No customer has a particular influence on the product or price.

Porters 5 Forces
Supplier Power- weak/moderate ANF does not own or operate any manufacturing plants. However, ANF receives its clothing from over 240 vendors who are mainly foreign manufacturers. Therefore, no one (or few) supplier(s) has significant power over the company. Barriers to Entry/ Threat of Entry - weak There are not many threats to entry into the market right now due to the poor economy (decreasing prices/low sales/ increased uncertainty) and the near luxury nature/ brand recognition of ANF. ANF would not have only minor difficulties exiting the industry. They do not have high exit costs since they do not own factories (only stores within high traffic areas such as malls). However, they do have somewhat of a specialized asset. Since their clothing has their label, it may not be as valuable to other stores.

SWOT Analysis
Strengths
Strong financial position as evidenced by balance sheet Excellent profit margins (66% gross, 19% operating, 12% net) Excellent Return on Equity: 29% over 5 years Steady and profitable growth Share repurchases Multiple strong and growing brands

SWOT Analysis
Weaknesses
$1.5 billion in contractual obligations over the next 5 years; expected to be paid out of cash from operations Highly dependent on consumer tastes and trends Dependent on consumer discretionary spending

Opportunities
International growth (few stores in Canada already generate 3x productivity of US counterpart; opening stores in UK; international direct to consumer grew 72% in 2007) Strengthening and growing Hollister brand

SWOT Analysis
Threats
Economic downturn reducing consumer spending, cutting into sales and margins Competition from other chains, specialty stores, department stores, etc. could eat away market share and hurt profits (especially lower-cost producers in this economic climate)

Financial Statement Analysis

Balance Sheet
2007 Current ratio Quick ratio Leverage 2.10 1.29 0.587 Third Quarter 2008 1.76 0.63 0.571

ANF is solvent, with an exception during 3rd quarter of 2008 due to economic slowdown Less than $200,000 of intangible assets: other assets + other current assets Inventory is a significant 29% of current assets

Financial Statement Analysis

Income Statement
2007 Net Profit Margin Return on Assets Return on Equity Cash Conversion Cycle Interest Coverage Ratio 12.7% 19.76% 31.47% 86 days N/A (no interest paid) 0.96 14.5% 4.3% Industry

Year-over-year growth was 13% in 2007 However, third quarter net income fell 46% in 2008 from its level in 2007 Compared to the industry, ANF has favorable ratios (above) Same store sales fell 14%

Financial Statement Analysis

Cash Flow and Valuation Ratios
2007

FCF/OCF
Short-Term Debt Coverage

.432
1.50

Abercrombie has adequate operating cash flow to easily cover its short term debt
2007 Price/Book Price/Earnings 0.7 2.8 Industry 1.1 7.7

Compared to other industry firms, ANF is cheap The P/E and P/B ratios are extremely low

Competitor Analysis & Valuation Metrics

American Eagle Outfitters
P/E: 6.6 P/B: 1.46 P/S: .57 D/E: 5.42% ROE: 27% Operating Margin: 15% Gross: 43% Sales: 3.08B Stores: 1,054

Gap
P/E: 9.36 P/B: 2.24 P/S: .57 D/E: 4.35% ROE: 21% Operating Margin: 11% Gross: 38% Sales: 15B Stores: 3,170

J. Crew
P/E: 6.91 P/B: 4.45 P/S: .41 D/E: 42.36% ROE: 21% Operating Margin: 11% Gross: 41% Sales: 1.44B Stores: 210

Competitor Analysis & Valuation Metrics

Industry (from Yahoo!) P/E: 7.1 P/S: .25 Operating Margin: 5% Gross: 41% Sales: 1.44B Abercrombie & Fitch P/E: 3.66 P/B: 1.03 P/S: .39 D/E: 5.58% ROE: 32% Operating Margin: 17% Gross: 67% Sales: 3.77B Stores: 3,170 Specific Advantages of ANF:
Has a lower P/E ratio than all its main competitors, showing that its undervalued and that comparatively you pay less for every dollar of earnings. Its competitors are not exactly the same as ANF, since ANF does not engage in sales. Thus, it keeps higher gross profit margins. It targets dedicated fashion-conscious buyers, not sale-seekers. It has 5 different brands, so it can serve more markets than its competitors. It owns two of the biggest brands in the industry, Abercrombie & Fitch and Hollister.

Weighted Average Cost of Capital

eta from CAPM= 1.08 Total Capital: $2.3M Total Debt: $100M (short-term debt) Total Equity: $2.2M Cost of Debt (4% of total capital): 1.80% Cost of Equity (96%): 8.98% Discount rate: 8.67%

DCF Model
Value Per Share: 28.38 Closing Price (12/01): 16.47 Assumptions:
Growth rates: -6.0%, 0.0%, 2.0%, 4.0%, 4.0%, 4.0%, 5.0%, 5.0%, 3.0%, 3.0%, 3.0% Percent revenue: 81 Other General Expenses (Net): 0% Goodwill Impairment (% revenue):0% Net Interest Expense (% revenue):-.2% Other Expense(% revenue) :0%

Assumptions cont.
Depreciation & Amortization: 5% Less: increase in Working Capital: 1% Less: Capital Expenditures: 11% Tax rate: 40% Discount Rate: 10%

Drawbacks
Abercrombie & Fitch, Co. sells discretionary consumer goods and we are in a recession, so consumption is down. They are forecasting a weak forth quarter, but we believe that is already incorporated into the price. The 14-30yr old fashion clothing market is very competitive and is susceptible to changes in tastes and styles. While two of their 5 brands are not doing well (RUEHL and Gilly Hicks), ANF is taking steps to rectify these losses and turn the brands back around.

Conclusion:
Why ANF?
ANF has low valuation ratios meaning its undervalued right now. It owns highly recognized and stable brands. The company targets many different niches within the fashion-conscious retail market via its brands, so there is less risk from changing trends. There is a lot of room for growth once the economy picks up and consumer spending increases.