ANF by iBCAxiom

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									Equity Research August 03, 2009 United States of America Retail Retail Softlines

Abercrombie & Fitch Co. (ANF - US$ 28.59) 1-Overweight
Recommendation Change
Upgrading to 1-OW; $35 Price Target

Investment Conclusion
We're upgrading ANF to Overweight and raising our price target to $35. Our more bullish stance is based on the revenue stream we expect from international flagship stores in 4Q09 coupled with lower cost of goods for 2010, which we expect to fund reductions in opening prices.

EPS (US$) (FY Jan)
2008
Actual 1Q 0.69A 2Q 0.87A 3Q 0.72A 4Q 1.10A Year 3.38A P/E Old -0.31E -0.05E 0.18E 0.99E 0.81E

2009
New St. Est. -0.31E -0.31A -0.10E -0.03E 0.27E 0.27E 1.03E 0.95E 0.89E 0.89E 32.1 Old N/A N/A N/A N/A 1.60E

2010
New N/A N/A N/A N/A 1.75E 16.3

% Change
St. Est. 2009 -0.09E -145% 0.16E -111% 0.44E -63% 1.18E -6% 1.54E -74% 2010 N/A N/A N/A N/A 97%

Summary
Comps have been challenging and we expect a below consensus 2Q at (-$0.10). We do see modestly better trends at Hollister, however, and believe comp trends can improve in back-toschool and into 4Q09. 4Q09 includes ANF flagship openings in Milan and Tokyo, and that should relieve some of the pressure in recent quarters from pre-opening expenses. We estimate these stores and the Hollister flagship opened in 2Q09 to add at least $25MM to the top-line in 4Q with more of the benefit in 2010 as stores ramp. Our FY 2009 moves to $0.89 based on upside in 2H from better margins and improved sales. Our 2010E goes to $1.75 as the co realizes benefits from US store closures and cost initiatives. Our PT is $35, 20.0x our 2010 est. as ANF recovers from a 4% est'd op margin in 2009.

Market Data
Market Cap (Mil.) Dividend Yield 52 Week Range 2555 3.04 57.25 - 13.66

Financial Summary
Revenue TTM (Mil.) 3352.2

Stock Overview
ABERCROMBIE & FITCH CO. - 7/ 3 1/ 20 09
55

Reuters ADR

ANF ANF

Bloomberg

45

35

Stock Rating
New: 1-Overweight Old: 2-Equal Weight

Target Price
New: Old: US$ 35.00 US$ 22.00

25

15 Volum e 5M Aug Sep Oct Nov Dec J an Feb Mar Ap r May J un J ul

Sector View: 2-Neutral

Source: Lehm anLive

Our upgrade is based on several factors: 1) We think the company is doing a better job incorporating an appropriate mix of fashion, particularly at Hollister. Fashion appears to be more on-trend with a strong plaid offering and a better mix of prints and dresses, in our view, and we think ANF wants to reduce the price gap in 2010; and

Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

PLEASE SEE ANALYST(S) CERTIFICATION(S) ON PAGE 4 AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 5
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Equity Research 2) We expect ANF to benefit from a number of flagship openings during 2H09, several of them in international markets that remain underpenetrated. The London flagship, opened in 2007, is significantly outperforming average ANF chain, comping “strongly positively” versus a -30% comp for the company in 1Q09. There are additional opportunities for international square footage growth longer term, as we discuss below. 3) Further solidifying our view is the work the company has done over the last couple of quarters to position itself. ANF first cut capex by 45.6% in 2009, implemented new assortments and new pricing at Hollister and Kids, and is currently focusing on lowering cost of goods (we think the effect on margins could prove significant) and reducing its U.S. footprint (the company closed 2 A&F stores, 2 abercrombie kids stores, and 1 Hollister store in 1Q with more potential closures by year-end). Lower AUC is more of a back half story as costs should begin to match lower AUR. We see the risk/reward as favorable with a back half that should include better comp trends and 2010 consensus estimates that appear too low given cost initiatives and flagship revenues. Our $1.75 estimate compares to consensus of $1.54 and our $35 price target applies a 20x multiple to that as ANF improves its margins of what we believe will be a 2009 trough of 4.1%. Our prior $22 price target was based on a 14.0x multiple and our prior 2010 EPS estimate of $1.60. The flagship strategy has clear risks going forward but we believe higher revenues can result in better leverage against a leaner cost structure in 2010. Better Fashion, Lower Price Points at Hollister Should Drive Demand As for brand relevancy, it’s important to note that fall 2009 is the first major attempt by ANF to free up its designers to offer some more trend right merchandise. The 2H09 collections includes a greater percentage of fashion SKU’s versus core styles. For back to school, the focus is on plaid shirts at both A&F and Hollister. Other items include a strong collection of women’s knit tops and mini skirts. We feel more strongly about improvement at Hollister, in terms of product. A better assortment in addition to lower, more attractive price points, helps bring Hollister pricing more in-line with American Eagle, which should bode well for the brand given the competitive landscape it operates in. As an example, plaid shirts at both Hollister and American Eagle are being offered at $39.50. We are forecasting a July comp of -23%, representing modest improvement in the two year trend over June. We are expecting further recovery in comp trends in the back half as comps benefit from easier comparisons, lower price points at Hollister and Kids, and a more fashion forward product assortment, which should help spur demand. Flagship Openings Should Produce Revenues to Offset Store Costs The company has incurred roughly $23 million in pre-opening expenses (mainly rent and labor) for stores opening in 2009 (Tokyo, Soho, Milan) since 4Q07 and expects an additional $15 million related to 2009 store openings this year, contributing to significant operating margin deterioration in 2008 and 2009. We expect strong revenues at new stores to drive operating margins higher in 4Q09 and 2010 by offsetting store costs. Flagships typically have higher profitability on a four wall basis compared to standard stores. Based on the success of existing flagships in London and New York, we estimate the new flagship stores could generate around $100 million in sales annually and roughly $50 to $80 million during the first year of operation. Using the lower end of that estimate, the Milan and Tokyo A&F flagship stores could recoup their pre-opening costs in under 5 months, and add $25 million to sales in 4Q09. As a point of comparison, a Hollister mall location that opened in May 2009, posted opening day sales five times the amount of a typical Hollister domestic store opening, according to the company. The London A&F flagship continues to comp “strongly positively” versus the average comp of -30% in 1Q09. The London flagship even showed sequential improvement in 1Q09 from the prior quarter as consolidated comps declined 5 points sequentially to -30% from -25%. We think this is a good indication of the brand awareness the company exhibits in the U.K. and potentially other European cities. As the brand gains increased awareness, we think the International Direct business could benefit as the company ramps up store openings in new international markets. As an example, the Direct business in the U.K. grew 100% during the quarter the London flagship store opened. Figure 1: Operating Margins for the Teen Sector
Operating Margins Teens AEO change ANF change ARO change Average 17.8% 17.3% 20.7% 14.8% 18.0% 3.15 23.5% 2.75 10.4% 13.4% (4.57) 20.5% (2.99) 8.0% (2.41) 14.0% 12.1% (1.27) 19.9% (0.61) 11.8% 3.80 14.6% 9.6% (2.49) 19.6% (0.30) 9.5% (2.34) 12.9% 9.3% (0.36) 19.4% (0.20) 12.0% 2.54 13.6% 19.3% 10.00 18.8% (0.57) 14.6% 2.58 17.6% 19.9% 0.58 20.0% 1.15 11.2% (3.34) 17.0% 21.0% 1.14 19.8% (0.14) 11.2% (0.05) 17.3% 19.6% (1.40) 19.7% (0.09) 12.6% 1.41 17.3% 10.3% (9.26) 13.3% (6.47) 13.2% 0.55 12.3% 9.6% (0.71) 3.8% (9.52) 15.5% 2.35 9.6% 11.4% 1.79 7.1% 3.36 15.7% 0.18 11.4% 14.7% 20.1% 7.0% 12.1% 15.7% 8.0% 17.4% 23.5% 3.8% 14.5% 21.0% 9.3% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E L/T Avg Peak Trough

Source: Company Reports and Barclays Capital estimates 2

Equity Research In Figure 2 below, we lay out the company’s store opening schedule for the remainder of the year. In addition, the company opened a Hollister flagship store in Soho, New York in June 2009 to what we believe to have been a strong reception. The store, which is 40,000 square feet (vs 6,700 for a typical Hollister store) is the first Hollister flagship. We see more of an opportunity for growth through expansion in Europe with more standard sized stores, as detailed below. There are currently 4 Hollister stores in the U.K. with ten expected by year end. We think the flagship concept could exist in key markets with tourist exposure, consistent with A&F flagships. Figure 2: Flagship Opening Schedule

Location Milan, Italy Milan, Italy Tokyo, Japan Copenhagen, Denmark New York City, USA Paris, France
Source: Company Reports

Brand A&F abercrombie A&F A&F abercrombie A&F

Scheduled opening Nov. 2009 Nov. 2009 Dec. 2009 2010 2010 2011

Figure 3: Existing Flagship Locations
Location New York City, USA Los Angeles, USA London, UK New York City, USA
Source: Company Reports

Brand A&F A&F A&F Hollister

Opening Date Nov. 2005 July 2006 Mar. 2007 June 2009

Square Footage 17,000 21,000 24,000 40,000

Greater International Opportunities Exist Longer Term Over a longer time horizon, we see significant opportunity for international expansion. ANF sees the potential to become a global company generating 50% of its revenues overseas. We think ANF reaches the 10% threshold for international sales in late 2009 or early 2010. We don’t see major opportunity for unit growth in the U.S. – we see growth coming from international markets with the most significant regions being Asia followed by Europe. In Europe, the company is working towards approximately 500 Hollister stores. We see this as achievable using the number of teens per store in U.S. Hollister markets (125,678) to get to a number of potential stores in Europe using the same number. Our analysis, as we show in Figure 4 below, uses several major European countries as a starting point. There is clearly opportunity for stores in other countries. Figure 4: European Hollister Store Potential over the Longer Term
U.S. Existing Stores Teen Population (ages 10 to 24) People Per Store Potential Stores based on People/Store Planned Store Openings in 2009 507 63,718,833 125,678 N/A 4 U.K. 4 11,860,600 125,678 94 6 Germany 0 14,000,000 125,678 111 1 Italy 0 8,861,472 125,678 71 1 France 0 11,300,000 125,678 90 0 Spain 0 6,900,000 125,678 55 0

Source: Population Reference Bureau, Italian National Institute of Statistics, U.K. Statistics Authority, Company Reports and Barclays Capital estimate

The company is considering 50 to 60 A&F flagship stores in Europe and Asia combined over the longer term. Management’s strategy has been to enter new markets with a flagship and potentially expand with standard-size stores. While the company has officially announced only 6 flagship locations so far, other possible locations mentioned to date include Germany, Spain and Sweden. Based on management’s previously announced flagship locations (Figure 2), the company seems to value the publicity and prestige a site could garner in addition to favorable demographics. We think the range of 50 to 60 stores may be high, but we certainly see opportunity for stores in major cities and tourist destinations. In Figure 5 below is a list of European and Asian cities ranked by tourist visitation. While the company has stores or is planning stores in these cities, we think there are a number of cities on the list that could play a part in the company’s international flagship expansion.
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Equity Research Figure 5: European and Asian Cities Ranked by Tourist Visitation (data in millions) Cities in Asia and Europe Tourist Arrivals

London Bangkok Paris Singapore Hong Kong Rome Seoul Barcelona Dublin Shanghai Kuala Lumpur Istanbul Madrid Amsterdam Prague Moscow Beijing Vienna Taipei St.Petersburg Macau Venice Warsaw

15,640 10,350 9,700 9,502 8,139 6,033 4,920 4,695 4,469 4,315 4,125 3,994 3,921 3,901 3,702 3,695 3,593 3,339 3,280 3,200 3,072 2,927 2,925

Source: Euromonitor International and Barclays Capital estimate

Analyst Certification: I, Jeff Black, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report.

Company Description: Abercrombie & Fitch is a mall-based specialty retailer of apparel and accessories under the Abercrombie & Fitch, abercrombie, and Hollister Co. brands. The company operates 897 stores and 3 websites.

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Equity Research
On September 20, 2008, Barclays Capital acquired Lehman Brothers' North American investment banking, capital markets, and private investment management businesses. All ratings and price targets prior to the acquisition date relate to coverage under Lehman Brothers Inc.

Important Disclosures: Abercrombie & Fitch Co. (ANF)
Rating and Price Target Chart: ABERCROMBIE & FITCH CO. (CL A)
As of 06-Jul-2009 Currency = USD 88.00 84.00 80.00 76.00 72.00 68.00 64.00 60.00 56.00 52.00 48.00 44.00 40.00 36.00 32.00 28.00 24.00 20.00 16.00 12.00

US$ 28.59 (31-Jul-2009)

1-Overweight / 2-Neutral

7-06

10-06

1-07

4-07

7-07

10-07

1-08

4-08

7-08

10-08

1-09

4-09

7-09

Closing Price Recommendation Change
Currency=US$ Date Closing Price 18-Jun-09 26.49 09-Apr-09 24.76 13-Feb-09 22.78 12-Jan-09 21.22 14-Nov-08 17.79 10-Nov-08 24.27 10-Nov-08 24.27 06-Nov-08 26.55 09-Oct-08 27.69 29-Sep-08 35.74 29-Sep-08 35.74

Price Target Drop Coverage
Source: FactSet

Rating

Price Target 22.00 19.00 21.00 17.00 20.00 28.00 31.00 36.00 50.00

2 -Equal weight

1 -Overweight

Date 15-Aug-08 07-Aug-08 11-Jul-08 16-May-08 21-Nov-07 22-Oct-07 22-Jun-07 22-Jun-07 18-Jan-07 06-Oct-06 22-Sep-06

Closing Price 52.59 49.80 52.61 76.19 74.77 77.98 73.71 73.71 79.48 73.69 68.44

Rating

Price Target 54.00 58.00 70.00 80.00 83.00 85.00 82.00 85.00 79.00 78.00

2 -Equal weight

FOR EXPLANATIONS OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHART.

Barclays Capital and/or an affiliate trade regularly in the shares of Abercrombie & Fitch Co.. Barclays Capital is associated with specialist firm Barclays Capital Market Makers who makes a market in Abercrombie & Fitch Co. stock. At any given time, the associated specialist may have "long" or "short" inventory position in the stock; and the associated specialist may be on the opposite side of orders executed on the Floor of the Exchange in the stock. Barclays Capital and/or an affiliate makes a market in the securities of this company. Valuation Methodology: Our $35 price target applies a 20x multiple to our 2010 estimate of $1.75. Risks Which May Impede the Achievement of the Price Target: We believe the long-term risks for Abercrombie and Fitch are (1) that comparable store sales remain sluggish for a protracted period of time, (2) the challenges associated with managing multiple store formats, (3) that Hollister, the Company's main growth vehicle experiences a slowdown, (4) that the new concept, Ruehl, does not gain traction and does not succeed, (5) the fashion risk associated with being a highly seasonal, highly cyclical, and fashion oriented business, and (6) the removal of import quotas could have a significant impact on worldwide sourcing patterns during 2005. Our earnings forecast and

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Equity Research investment thesis for Abercrombie and Fitch are subject to such factors as cost of goods, consumer spending and debt levels, currency fluctuations, interest rate fluctuations, store expansion plans, legal proceedings, and variability in comparable store sales.

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Equity Research Important Disclosures Continued: The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by investment banking activities.

Company Name Abercrombie & Fitch Co.

Ticker ANF

Price US$ 28.59

Price Date 31-Jul-2009

Stock / Sector Rating 1-Overweight / 2-Neutral

Guide to the Barclays Capital Fundamental Equity Research Rating System: Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2-Equal Weight or 3-Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (the “sector coverage universe”). Below is the list of companies that constitute the sector coverage universe: Abercrombie & Fitch Co. (ANF) American Eagle Outfitters (AEO) Chico's FAS, Inc. (CHS) DSW Inc. (DSW) Guess Inc. (GES) Limited Brands, Inc. (LTD) TJX Companies (TJX) Aeropostale Inc. (ARO) AnnTaylor Stores Corp. (ANN) Coldwater Creek Inc. (CWTR) Gap Inc. (GPS) J. Crew Group, Inc. (JCG) Ross Stores (ROST) Urban Outfitters (URBN)

In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investors should carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone. Stock Rating 1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon. 2-Equal Weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12- month investment horizon. 3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12- month investment horizon. RS-Rating Suspended - The rating and target price have been suspended temporarily due to market events that made coverage impracticable or to comply with applicable regulations and/or firm policies in certain circumstances including when Barclays Capital is acting in an advisory capacity in a merger or strategic transaction involving the company. Sector View 1-Positive - sector coverage universe fundamentals/valuations are improving. 2-Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating. 3-Negative - sector coverage universe fundamentals/valuations are deteriorating. Distribution of Ratings: Barclays Capital Equity Research has 1206 companies under coverage. 36% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 45% of companies with this rating are investment banking clients of the Firm. 48% have been assigned a 2-Equal Weight rating which, for purposes of mandatory regulatory disclosures, is classified as a Hold rating; 37% of companies with this rating are investment banking clients of the Firm. 14% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Sell rating; 30% of companies with this rating are investment banking clients of the Firm. Barclays Capital offices involved in the production of Equity Research: London
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Equity Research Barclays Capital, the investment banking division of Barclays Bank Plc (Barclays Capital, London) New York Barclays Capital Inc. (BCI, New York) Tokyo Barclays Capital Japan Limited (BCJL, Tokyo) São Paulo Banco Barclays S.A. (BBSA, São Paulo)
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