Ty Walrod

What a late one... my Investments group has been working on a long stock valuation project for the apparel industry; actually we're analyzing the economy, industry, and specifically Abercrombie & Fitch, American Eagle Outfitters, and The Gap. Our evaluation has analyzed the economy through October 2005, the retail apparel industry to date, and each individual company. Research for each company has included historical reports, five years of financial statements (specifically the income statement and balance sheet), and key ratios derived from the financial statements and the market (including, liquidity: current ratio and net working capital; activity ratios: A/R turnover, inventory turnover, and TAT; Leverage measures: Debt/Equity and Times Int Earned; Profitability measures: NPM, ROA, ROE; and Common Stock Ratios: P/E, Div Yield, EPS, Payout (using dps/eps) and BV/share). Using geometric growth rate on EPS, P/E, Sales, and a modified growth rate on dividends, we were able to project three years for each of the preceding, as well as three years of stock prices. From that we calculated internal rate of return for each company.

And you know what: They all sucked. The only company with a positive IRR was A&F, which, after the success of Hollister Co. is launching a new venture called RUEHL for the 22-35 year old (which will compete with The Gap's Banana Republic for market share). The only company with long-term debt in its capital structure is The Gap, but at its size and (relative) stability, this appears to be acceptable. Overall, some may argue that A&F is overvalued (it is trading at 17x is per-share earnings);

However, being the trend-conscious, young 22-year old guy that I am, I personally believe that Abercrombie & Fitch may put Gap up for a good fight in RUEHL v. Republic of Bananas war; and while Hollister takes knocks at American Eagle for our high schoolers, Abercrombie's flagship stores will continue the battle with the Gap for the trendy, sexy young adult demographic.

I still buy my jeans at the Gap though. Boxers at the Gap/A&F. Dress shirts at the Gap/A&F. And Paul still gets his shirts at American Eagle. Something for everyone I guess.

And there you have it; A&F is trading at $62.94, AE at $24.22, and Gap at $17.47. Abercrombie and the Gap are winning the youths' of America taste test with trends, but AE has increased profitability so significantly that it may throw itself back on the charts and displace business at both its rivals, and it has just opened up 41 new stores. We have yet to see what happens.

Recommendation: Sell A&F, Buy AE, Hold Gap, and download the latest A&F wallpaper.