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3 Reasons Why Abercrombie Is Trading at a Discount

Wednesday - 3/20/2013, 1:50pm  ET

Abercrombie & Fitch , the specialty retailer of casual apparel, last reported earnings on Feb. 22. Gazing back at the fourth quarter and full year earnings announcement and the  trajectory of the company's share price, Abercrombie seems to have fallen victim to the classic Wall Street "pump and dump." From mid Jan. through Feb. 21, Abercrombie's stock inched steadily higher, nearly touching its 52-week high of $54.05. Then, as soon as earnings were announced, the stock headed south like U.S. downhill skier Lindsey Vonn, hitting nearly $45/share, good enough for a ~15% decline. This steep sell-off flew in the face of positive news that the New Albany, Ohio-based company delivered record fourth-quarter sales, met top-line revenue guidance, beat earnings estimates and posted strong full-year results. Below are three reasons why now is a nascent time to consider buying Abercrombie & Fitch.

Retail sales are regaining their footing
On Mar. 13, the U.S. Commerce Department reported a 1.1% increase in retail sales for the month of Feb. 2013, the fourth consecutive month of gains. This unexpected rise means consumers are regaining confidence in the American economy. To bolster the retail sales story even further, the Commerce Department also reported that U.S. business inventories in Jan. 2013 also grew by 1%, suggesting that American companies are seeing increased demands for their products. A senior economist with Capital Economics, Paul Dales, believes "the pickup in both employment and earnings growth bodes well for consumption growth later in the year." It appears that Abercrombie will finally be working against a rosier economic backdrop, which should result in stronger growth in the quarters ahead, along with an escalating stock price.

Abercrombie is undervalued and trouncing peers in gross profit
Let us quickly run down some peer retail comps on Abercrombie, starting with Abercrombie itself. The trend-setting retailer, adored by the teen and tween audiences, has a trailing P/E (ttm) of 14.84, a price-to-book (mrq) of 2.16, and a gross profit of $2.52 billion, according to Capital IQ. Aeropostale , Abercrombie's arch rival, enjoys significantly higher business valuations with a trailing P/E of 16.85, a price-to-book of 3.18, and gross profit of just $1.39 billion. Let me reiterate that last data point again, for emphasis. Abercrombie delivered gross profit of $2.52 billion, 45% higher than Aeropostale--with nearly the same number of storefronts and a comparable market capitalization. When you add Philadelphia's Urban Outfitters  to the mix, Abercrombie's current valuation appears even more out-of-whack. Urban boasts a trailing P/E of 24.25, a price-to-book of 4.32 and gross profit of just $860.54 million. All of these metrics easily make the case that Abercrombie is trading at a considerable discount to its peer group.

Margins are being managed to the upside
Abercrombie's gross profit rate, a key metric for apparel retailers, clocked in at more than 63% for the fourth quarter. This figure is completely unmatched by competitors, with Aeropostale 2,000 basis points behind at 40% and Urban Outfitters lagging the pack at just 37%. Even America's bellwether apparel retailer, The Gap  clicks in at just 39%. On a year-over-year basis, Abercrombie greatly improved its gross profit rate by more than 9% by decreasing average unit costs, marking down carryover inventory in the prior year and buckling down with "continued tight expense control," according to Abercrombie CEO Mike Jeffries in the company's Feb. 22 press release. 

Nearly a month after a strong fourth quarter and full year earnings release, Abercrombie is still trading in the mid-40s. Investors searching for undervalued stocks with stand-out profit margins would be wise to take a lengthy gander at Abercrombie and consider building a position. 

This article was originally published as 3 Reasons Why Abercrombie Is Trading at a Discounton Fool.com

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