I'm Doubling Down on This 'Beyond Cheap' Retail Play
Despite my caution on retailers, the stock is now too undervalued to ignore. Here is how I'm building a larger position.
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I have been hugely underweight the retail sector for the better part of a year and a half now. This is mainly due to my concerns about the health of the majority of consumers. That has been the right call for the most part.
Concerns around a slowing economy and the potential impacts of new tariffs are just the latest worries for this part of the market. Indeed, these headwinds helped to crush Nike NKE at the end of last week.
One exception to my avoidance of retail came last September when I dipped a toe into the sector and opened a small position in Abercrombie & Fitch ANF via a covered call trade. It turns out I was way early in my timing on that trade as the stock has been shellacked in the market in recent months along with most of the rest of the sector.
The slide has happened despite Abercrombie & Fitch slightly beating the top and bottom-line consensus when it reported fourth quarter results early in March. But like most retailers, its leadership gave a cautious initial outlook for 2025, which sent the shares into a tailspin.
At this point, ANF stock is beyond cheap based on several valuation metrics and I more than doubled my position via covered call orders in recent trading sessions. With the recent pullback, ANF has a market capitalization of around $4 billion.
One of the best things about this retail play is that it has a rock-solid balance sheet. Abercrombie had nearly $900 million of cash and marketable securities at end of fiscal year 2024. The company has retired all of its long-term debt and recently authorized a $1.3 billion stock buyback program. Management expects to execute $400 million of that authorization in FY 2025. This is nearly 10% of the stock’s overall float at current trading levels.
The stock is not being punished because the company delivered poorly in FY 2024. Abercrombie & Fitch posted record earnings on 16% year-over-year sale growth during the fiscal year. The fourth quarter was also solid with comparable (same-store) sales growth of 14% compared to the same period in FY 2023.
However, increasing worries about the health of the consumer as well as the potential impacts of new tariffs on the company led to conservative guidance for the first quarter and for FY 2025. That has pushed the shares down just below $80.
It should be noted that about 80% of the retailer’s overall sales come from the U.S. It is true that the company outsources almost all of its production from overseas, which does make it vulnerable to new tariffs. Still, Abercrombie garners production from 17 different countries, so it should be able to mitigate this risk by moving more production to those facilities that have the lowest tariff impact.
Even with conservative guidance, management believes the company will deliver a slight rise in earnings per share in FY 2025 on revenue growth of 4%. The recent selloff in the stock leaves the shares trading for less than 7.5 times trailing earnings. That's much too cheap given Abercrombie’s pristine balance sheet. It should also be noted the company easily stepped over management’s conservative guidance from the start of the year when all was said and done in 2024.
Option Strategy
This is how one can initiate a holding in ANF with a covered call order. As a reminder, covered call orders involve buying an equity and simultaneously selling just out of the money call strikes against the new position.
Using the November $75 call strikes, fashion a covered call order with a net debit in the $61.50 to $62.00 a share range (net stock price - option premium).
This strategy provides downside protection of 22% with upside potential of 21% even if this equity trades down slightly over the option duration.
At the time of publication, Jensen was long ANF.
