The Street Is Bullish On This Beaten-Down Retailer

I was chatting with a wealthy friend last week about the portfolio returns on my website. He interrupted me with an odd question: “Yeah, but how much did a millionaire make?!”

#-ad_banner-#I wasn’t quite following him, and then it struck me. He was under the impression that large stock transactions earn a higher percentage of profit than small transactions do. And he was wrong.

My friend is a self-made man, with several successful careers under his belt… but clearly none of them required a good working knowledge of math.

When a stock goes up 10%, all shareholders make 10% profit — from the millionaire down to the guy who owns just one share. For example, Gilead Sciences (NYSE: GILD) is up 13.6% since I wrote about it a couple of months ago. All investors who bought then are up 13.6%, with slight variations based on transaction fees.

(Fees are a factor, yes, but you can’t assume that the rich guy pays lower fees. As a matter of fact, small investors often manage their own accounts, with ridiculously low transaction fees, and millionaires frequently pay somebody an annual fee to manage their accounts. The case could be made that the small investor has a lower-fee advantage.)

The stock I want to profile today has posted an 85% total return over the past five years — for millionaires and less well-heeled investors alike. 

Abercrombie & Fitch (NYSE: ANF) is a global fashion retailer, with over 1,000 stores. The company has been in business for 122 years and sells a wide variety of casual luxury apparel through four brands that target children, teens and young adults.

Abercrombie is at a pivotal point. After sales reached a record $4.5 billion in fiscal 2013, sales fell to $4.1 billion in fiscal 2014, and are expected to fall again in the current fiscal year, to just over $4 billion, followed by a slight increase next year.

  Abercrombie & Fitch is a 122-year-old company that has more than 1,000 stores around the world.  

So the key questions are: What is management doing to turn the situation around, and will the turnaround efforts be successful?

Recent management changes have resulted in new brand presidents and a new chairman. In June, Abercrombie hired Christos Angelides, a former group product director for Next PLC (OTC: NXGPF), a U.K. fashion retailer that’s about 50% larger than Abercrombie, as president of its Abercrombie & Fitch and Abercrombie Kids brands.

Wall Street is expecting Abercrombie to address its fashion viability and competitiveness vs. other fast-fashion retailers, such as Forever 21.

The board of directors also experienced a shake-up this year, with three board members departing as their terms expired. Activist investor Engaged Capital persuaded the company to appoint four new independent directors to its board.

Abercrombie’s cost-cutting efforts are ongoing, including the closing of more than 60 stores and the restructuring of its Gilly Hicks brand. Growth in higher-margin sales, including both internationally and online, is contributing to increased profitability. Standard & Poor’s forecasts Abercrombie’s margins on earnings before interest and taxes (EBIT) will climb from 5.4% in fiscal 2014 to 6.9% in 2015 and 8% in 2016.  

Abercrombie posted $1.91 in earnings per share (EPS) in fiscal 2014 (before restructuring charges). The consensus estimate for EPS growth is 24% this year to $2.36, and another 19% next year to $2.80. That projection is higher than Abercrombie’s recent guidance, indicating that the Street is expecting aggressive earnings growth.

Abercrombie’s balance sheet is strong, with plenty of cash for dividends, share repurchases, and keeping debt at bay. The forward yield is 1.9%, with a payout ratio of 34% on estimated fiscal 2015 earnings. The long-term debt-to-capitalization ratio is 9.4%. And Abercrombie recently authorized a repurchase plan for 16.3 million shares.

ANF is a mid-cap growth stock. Ninety percent of its shares are held by institutions, with Fidelity Investments owning the biggest position, a 13.5% stake. 

Abercrombie’s share price has been slowly improving all year. The stock broke out of another trading range in mid-June, and is heading toward short-term price resistance at $46. I expect the stock to pause there, then head toward the next resistance level at $54. At that point, today’s investors will have a total return of about 31%.

Risks to Consider: A weakening global economy, fashion and inventory risk, or delayed store openings could keep ANF from performing as expected. With a beta of 1.8, Abercrombie’s stock is distinctly more volatile than its teen apparel peers.

Action to Take –> Abercrombie shares should appeal to value, growth and income investors alike. My target price is $47.20, based on an increase in ANF’s price-to-earnings (P/E) ratio to 20, which is in the upper end of its historical range and represents upside of 14%.

ANF’s 1.9% dividend yield probably won’t satisfy many yield-starved investors. If you’re looking to maximize your dividend income, you’ll want to hear about Amy Calistri’s “Daily Paycheck” strategy. By combining three different types of dividend-paying stocks, she’s collecting more than $1,350 per month in dividend checks. And an incredible 91% of the picks in her Daily Paycheck advisory are winners. Click here for the full story.