UNIVERSITY OF OREGON INVESTMENT GROUP April 29, 2009 Consumer Goods Abercrombie & Fitch (ANF) BUY Stock Data Price (52 weeks) 29.94-70.49 Symbol/Exchange NYSE: ANF Beta 1.39 Diluted Shares Out. 89.90M Average daily volume 2.74M (3 month average) Current market cap 6.28B Current Price Dividend Dividend Yield $69.88.17 1.01% Valuation (per share) DCF Analysis $72.89 (50%) Comparables Analysis Target Price Current Price $113.74 (50%) $93.32 $69.88 Summary Financials Revenue Net Income Operating Cash Flow 2010A $3.47B $150.30M $381.69M BUSINESS OVERVIEW Abercrombie & Fitch is an American company founded in 1892 and is based out of New Albany, Ohio. Abercrombie has changed its product offerings many times, and was even forced to file for chapter 11 bankruptcy in 1976. Before becoming the specialty apparel retailer it is today, the company was an outdoor store that sold guns, fishing rods, and various other outdoor supplies. About 10 years after its bankruptcy, the company was sold to The Limited Group. Shortly after this purchase, Limited CEO Leslie Wexner disbanded interest in the company and handed off operations Covering Analysts: Elan Gibb & Ari Siegel Email: egibb@uoregon.edu & asiegel@uoregon.edu The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational. Member students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be. Members of UOIG may have clerked, interned or held various employment positions with firms held in UOIG s portfolio. In addition, members of UOIG may attempt to obtain employment positions with firms held in UOIG s portfolio.
to the current CEO, Michael Jeffries. The company was taken public later that year and had its initial public offering at $11.50. Management states that the most valuable piece of property that the firm owns is its brand image. Today, Abercrombie generates revenue through clothing and fragrance sales through the following brands: Abercrombie & Fitch, Hollister, abercrombie kids and Gilly Hicks. Each of these product lines has its own distinct style and associated target market. Abercrombie & Fitch targets young adults aged 18-22 and sells jeans, dress shirts, shorts, fragrances, and a number of other products for both men and women. These products are designed to be casual luxury and offer consumers with both quality and style. The company has had a high level of success in the fragrance segment and Abercrombie s Fierce brand cologne is the best-selling men s fragrance in the United States. There are currently 325 stores dedicated to this product line. Hollister is a Southern California-inspired brand that targets ages 14-18, and has a very similar, yet lower priced selection of products. Hollister is the largest revenue generator for ANF, and there are now Gilly Hicks, 1% 540 Hollister stores worldwide. Abercrombie Kids targets children aged 7-14, and has a rugged and athletic appeal. Styles are almost identical to those of A & F, but are marketed to a younger age group. abercrombie kids has 185 stores worldwide, and more store openings are planned for the future. Hollister, 45% A & F, 43% Gilly Hicks offers underwear and loungewear exclusively for women ages 18 and up. This brand is very similar to Victoria s Secret in terms of product design, price, and age group. The product abercrombie, 11% line is in its infant stages, but its success is gaining momentum. Styles range from casual to sexy and are inspired by Australian design. Gilly Hicks is currently the least substantial source of company revenue at 1%, with only 19 stores in operation. Abercrombie plans to continue operating all of these segments and does not have plans to acquire new companies or to change their brand mix in the near future. BUSINESS AND GROWTH STRATEGIES Abercrombie holds a prominent position in the domestic space and operates stores in North America, Europe, Japan, and Canada. At the end of the company s 2010 fiscal year, there were 1,069 total stores in operation, made up of 1,017 stores in North America and 52 stores internationally. At the end of FY 2010, domestic revenue contributed 81% of total revenue with the remaining 13% and 6% coming from the international and direct to consumer (DTC) segments, respectively. DTC, which are sales through the company s websites, are expected by management to grow substantially and to reach about $1 Billion, or roughly 11.3% of total sales over time. However, by far the largest growth opportunity for this company comes from the large-scale international expansion which will occur primarily between 2011 and 2015. Management has set the goal to shift from a 13% international, 81% domestic focus to one equally weighted at 50% by 2015. There are a number of factors that will contribute to the success of this expansion. The most important factor is the extreme popularity of Abercrombie stores abroad. As an example, the 50 stores that have been opened overseas are currently producing almost three times as much revenue as an equivalent number of stores at home. In addition, management plans to open twenty international flagship stores by the end of FY 2012. Flagship stores are unlike typical mall-based stores due to the fact that they are large standalone buildings which contain substantially more floor room, lavish décor, and all products sold under the A & F name. These stores are strategically positioned in high-end shopping areas that bring in a high volume of shoppers 2
with high levels of disposable income. The A & F flagship stores are typically placed next to very high-end luxury stores such as Louis Vuitton, Dior, Gucci, and Prada. This strategic placement is critical to the growth of the brand, allowing the company to charge higher prices and achieve significantly higher margins than is possible in the domestic space. There are currently flagship stores in New York, London, Tokyo, Milan, Copenhagen, and Fukuoka. Management expects that the combination of the five existing, and five confirmed (by 2011) international flagship stores will contribute $450 Million annually in sales. The following graphic shows the main A&F flagship stores that will fuel these expected 2011 growth levels, and also confirmed 2012 flagship locations: Location Paris Madrid Singapore Brussels Dusseldorf Dublin Hamburg Hong Kong Expected 1Q11E 3Q11E 4Q11E 4Q11E 4Q11E 2012E 2012E 2012E Aside from the substantial growth that will be attained through these Abercrombie & Fitch flagship stores, Hollister stores are also expected to play an important role in international expansion as well. There are currently 29 Hollister stores spread over four countries, however management believes that the Asian and European markets can handle 185 stores spread over 15 different countries. Given this number of stores, management expects $1.5 Billion in annual revenue to be contributed by Hollister stores abroad. Hollister will expand internationally using a mallbased model, as opposed to using a high-end flagship model. This strategy is in line with Hollister s target consumer, since the brand has a stronger focus on casual, as opposed to more luxurious products. Overall, the most important factor to achieving significant growth is management s ability to manage the brands they operate and to continue to focus on quality. This key driver is also where management s core competencies lie. During 2008, CEO Michael Jeffries refused to cut prices to stimulate sales growth in order to preserve the strong brand image that the company has spent years developing. During this time Jeffries also stated that the company would not lower the quality of input materials during this period in order to increase profits. As a result of this strategy, short-term stock performance suffered, however the company emerged from its 2008 low of $14.64 and appreciated by 378%, to $70 per share. Since a strong brand image is critical to the success of the company moving forward, management s strategy for preserving this image will play a pivotal role in the success of expansion in these markets. MANAGEMENT AND EMPLOYEE RELATIONS Michael Jeffries has been involved in the consumer retail space since 1968 and has been CEO of ANF since 1992. Jeffries is credited with the profitable transformation of the company over time. In 1992 when Abercrombie sold books, gardening supplies, and cooking supplies the company was again on the verge of bankruptcy. Since then, Jeffries has transformed the failing business into a multi-billion dollar retailer with a strong brand image and demand 3
for its products worldwide. As of March 23, Jeffries held 999,941 shares of ANF with a (current) market value of about $70 Million. Jeffries' FY 2009 total compensation was $36.3 Million including salary and stock options. Jonathan Ramsden has held positions both as Executive Vice President and Chief Financial Officer of the company. Ramsden is currently the CFO of Abercrombie, and has served as CFO for TBWA Worldwide, an international advertising agency. He also served as Controller and Principal Accounting Officer for Omnicom Group, a publicly trade multi-billion dollar advertising firm. Ramsden's FY 2009 total compensation was $743,900 including salary and stock options. The top five institutional and mutual fund holders of Abercrombie & Fitch stock are as follows: Institutional Holder Shares % Outstanding Columbia Asset Management 5,684,900.00 6.52% Vanguard 4,371,611.00 5.01% Bank of NY Mellon Corporation 3,616,605.00 4.15% Pennant Capital Management 3,353,337.00 3.84% State Street Corporation 3,352,262.00 3.84% Mutual Fund Holder Shares % Outstanding Fidelity Low-Priced Stock 8,000,000.00 9.17% Columbia Acorn Fund 2,835,000.00 3.25% Columbia Acorn Select Fund 1,600,000.00 1.83% Calamos Growth Fund 1,075,000.00 1.23% Vanguard Mid-Cap Index Fund 1,026,313.00 1.18% RECENT NEWS 4-6-2011 Abercrombie Rises on Bullish Outlook- Seeking Alpha Abercrombie shares rose 11% on April 6 th after the company provided an optimistic outlook for fiscal 2011, suggesting operating margin improvements as well as giving a $7.5 billion sales target for 2015. Management gave guidance of $4.75 of earnings per share for the fiscal year ended January 2012. 4-12-2011 A& F Downgraded- Wall Street Journal Argus cut its short term view on Abercrombie to a Hold from a Buy saying some of the retailer s projections are a bit aggressive. Longer term, Argus says Abercrombie remains a buy as it likes the company s focus on overseas growth. 4
INDUSTRY The Specialty Apparel Retail Industry is comprised of businesses that sell luxurious clothing items to end consumers through brick-and-mortar stores, online websites and direct-to-consumer sales. Companies keep their products relevant through the branding of clothing lines, and maintaining this brand equity is mandatory in order to maintain the success of the clothing. Major retailers today include Abercrombie & Fitch, Aeropostale, American Eagle, Bebe Stores, Limited Brands, and many others; however due to the capricious nature of fashion trends, new businesses are constantly entering the market. Profit margins are slightly higher within the specialty apparel retailers industry compared to the broader apparel industry, however on an absolute scale margins are still low. The most significant expenses in order of magnitude are cost of goods sold, wages, and product distribution. Maintaining a strong brand image is just as important for the top line as for the bottom line, as better known products enjoy pricing premiums over their generic counterparts. Due to the luxurious nature of specialty apparel, the industry is particularly sensitive to changes in economic conditions. The economic recovery and preceding recession has led to particularly volatile industry performance over the past few years. Same-Store sales across the industry dropped in 2008 and 2009, followed by a partial recovery in 2010. In the near term, important macro indicators for the industry as a whole include consumer sentiment, commodity prices, disposable income, and the unemployment rate. Monthly economic reports on retail sales and business inventories also add insight into the health of the industry. As a whole, the outlook of specialty apparel is brightening, with same store sales expected to increase industry wide in 2011 and onward as the economy recovers. This has been driven in the short term by increases in consumer sentiment, however the drivers of this momentum are transferring to more fundamental factors such as improved business conditions, slowly improving employment and slowly increasing disposable income. Key indicators affecting future demand for the specialty apparel retail industry can be referenced below: Several significant underlying trends are currently affecting the industry. The most important to note is a shift to online sales from traditional in-store sales. Online sales are currently growing at almost three times the rate of in store sales, and are thus becoming an increasingly larger portion of the top line for specialty apparel retailers. In addition, these sales tend to have proportionally higher margins, and so their effect on the bottom line is amplified even further. Second, specialty apparel retailers are increasingly going to international markets looking for growth. In contrast to 5
normal apparel brands, this increasing international presence is a relatively new trend for more specialized brands. Specialty retailers that have maximized their potential at home are finding new and significant opportunities in Europe and Emerging Markets. Finally, cotton and oil are significant inputs in clothing production and distribution, and prices for these commodities were up significantly for the year due to turmoil in the Middle East. In the short term this will drive margins down, however commodity prices are expected to return to more normal levels in the next few years as evidenced by the following futures curves: S.W.O.T. ANALYSIS Strengths - Healthy liquidity and cash cushion - Management team experienced in creating new and successful product lines - Strong brand equity abroad Weaknesses - Weak brand equity at home - Sensitivity to economic conditions Opportunities Threats - Significant growth potential abroad - Gilly Hicks product line - Potentially decreasing brand equity at home PORTER S 5 FORCES ANALYSIS Supplier Power - Low and steady: Suppliers of cotton are largely price takers on the international market Barriers to Entry - Low and steady: Clothing lines are cheap to produce and easy to brand, little capital is required to open clothing stores online or in malls 6
Buyer Power - High and steady: Consumers are sensitive to price movements and it is difficult for retailers to pass on large cost increases to customers Threat of Substitutes - High and steady: Generic clothing is easily accessible Degree of Rivalry - High and steady: Due to ease of entry, there are a large number of competitors in the industry CATALYSTS - Increasing/Decreasing momentum of sales abroad - Increasing/Decreasing momentum of Gilly Hicks Brand COMPARABLES ANALYSIS Comparable companies were chosen based on similar risk and growth. Potential indicators of these factors include consensus forecasts, beta, product similarities, and other metrics shown in the comparables valuation in Appendix 1. EV/EBITDA was the only multiple selected for the relative valuation. Top line multiples were not included due to incomparable margins and cash flow multiples were not used due to excessive volatility. The following table shows expected consensus EBITDA growth rates for all comparable companies used in this valuation: Consensus EBITDA growth expectations 2011 2012 2013 2014 ANF 26.1% 32.0% 29.6% 26.9% DECK 7.5% 18.7% LULU 26.4% 27.6% 38.6% 29.6% UA 27.2% 21.0% 24.7% 7.3% ZUMZ 13.3% 13.5% 13.3% 15.5% Deckers Outdoor Corporation (DECK)- 35% Deckers Outdoor Corporation, incorporated in 1975, is engaged in designing, producing, marketing and brand managing of footwear and accessories. The Company sells its products, including accessories, such as handbags, headwear, packs and outerwear, through domestic retailers and international distributors and directly to the consumers, both domestically and internationally, through its Websites, call centers, retail concept stores and retail outlet stores. The Company markets its products under three brands: UGG, Teva and Simple. The Company acquired 100% of the ownership interest of Ahnu, Inc. in March 2009. -Reuters Deckers was chosen as a comparable company and weighted 35% as a result of similar forward-looking growth and similar sensitivity to economic conditions. Deckers was also chosen on the basis that it has a very similar geographic mix and also sells products using a direct to consumer model. In addition to these factors, Deckers is similarly sized and has significant growth expected from international markets. 7
Zumiez Inc. (ZUMZ)- 30% Zumiez Inc. is a mall-based specialty retailer of action sports related apparel, footwear, equipment and accessories operating under the Zumiez brand name. As of January 30, 2010, the Company operated 377 stores primarily located in shopping malls, giving it a presence in 35 states. Zumiez s stores cater to young men and women between the ages of 12 and 24 who seek brands representing a lifestyle centered on activities that include skateboarding, surfing, snowboarding, bicycle motocross (BMX) and motocross. Most of the Company s stores, which average approximately 2,900 square feet, feature couches and action sports-oriented video game stations. -Reuters Zumiez was chosen as a comparable company and weighted 30% for similar reasons as Deckers. Its growth and risk are very comparable, and its business model is the classic specialty retailer format. The 5% discount to Deckers was due to its size difference and also the company s lack of international exposure. Zumiez currently only sells its products internationally through direct to consumer methods and does not operate international stores. Under Armour, Inc.- 20% Under Armour, Inc. (Under Armour), incorporated in 1996, is engaged in developing, marketing and distributing branded performance apparel, footwear and accessories for men, women and youth. Its products are sold worldwide and are worn by athletes at all levels, from youth to professional, on playing fields, as well as consumers with active lifestyles. Its revenues are generated primarily from the wholesale distribution of its products to national, regional, independent and specialty retailers. Under Armour s products are offered in over 20,000 retail stores worldwide. Most of its products are sold in North America. The Company s trademarks include Under Armour, Heatgear, Coldgear, All Season Gear, and the Under Armour UA Logo. The Company s product offerings consist of apparel, footwear and accessories for men, women and youth. Under Armour was weighted at 20% due to comparable growth and risk, like all other companies chosen in the comparables analysis. The company does not have a presence in international markets, and it sells sports apparel as opposed to daily use clothing. For these reasons Under Armour was weighted slightly less than Deckers or Zumiez. In addition, Under Armour often sells its clothes through broader apparel stores as opposed to mall-based locations. Lululemon Athletica Inc. (LULU)- 15% lululemon athletica inc., incorporated on November 21, 2005, is a designer and retailer of technical athletic apparel primarily in North America. Its yoga-inspired apparel is marketed under the lululemon athletica brand name. The Company offers a line of apparel and accessories, including fitness pants, shorts, tops and jackets designed for athletic pursuits, such as yoga, running and general fitness. As of January 31, 2010, its branded apparel was principally sold through 124 stores that are primarily located in Canada and the United States. As of January 31, 2010, its retail footprint included 45 stores in Canada, 70 stores in the United States and nine franchise stores in Australia. Reuters LULU and ANF both offer products to consumers with higher levels of disposable income. In addition to both companies operating in the specialty retail industry, LULU also has very similar expected EBITDA growth over the next five years. It s less substantial weighting was a result of continued significant long term growth potential that was not reflected in short-term consensus forecasts. Lululemon s domestic growth potential in comparison with Abercrombie s was also factored into the decision to weight the company at 15%. LULU also has higher margins as it will have the ability to continue to charge a price premium in the domestic market. 8
DISCOUNTED CASH FLOW ANALYSIS Revenue Revenue was forecasted through a same store sales model that divided operating segments into domestic, international and direct to consumer sales. The number of stores for the domestic and international segments were forecasted and revenue per store was then forecasted through same store sales growth. The Direct-To-Consumer segment was forecasted proportional to the number of in store sales. Domestic Revenue Over the next decade, domestic revenue growth will be modest. In the short term management plans to close the most inefficient stores out until 2014, causing the average revenue per store and thus same store sales growth to increase. In addition, economic recovery and the Gilly Hicks line will contribute to same store sales growth. After all inefficient stores have been closed, the total number of stores and revenue per store are expected to moderately increase into perpetuity. International Revenue A significant number of international store openings are forecasted throughout the revenue model as Abercrombie moves forward with its overseas expansion plans. Revenue per store in Europe and elsewhere is significantly higher than within North America due to higher levels of popularity of the Abercrombie brands and the use of flagship stores. Because the current stores overseas are already seeing such high sales volumes, additional stores will likely not raise the average revenue per store significantly. Thus, international same store sales are forecasted to grow slowly, with total growth being driven by store openings. Other Direct-To-Consumer sales are expected to significantly increase as more consumers purchase their Abercrombie apparel online as opposed to in store. Currently Other sales make up about 6% of total revenue, and this proportion is forecasted to more than double by 2020. Gross Margin Cost of Revenue should remain relatively flat over the next two years as commodity pricing pressures net out with gross margin improvements from increasing international sales. After these input pricing pressures recede, gross margin should slowly improve as international sales become a proportionally larger part of total revenue. Annual gross margins were forecasted through estimating operating segment margins and the percentages of total revenue that these operating segments made up. Appendix 6 contains the model used to compute gross margin. Stores & Distribution Expense Distribution expenses will decrease as a percent of revenue over the next two years as management consolidates its two distribution centers into one. After the benefit from this consolidation, distribution expenses are expected to increase as a constant percentage of revenue. Selling, General & Administrative Expense SG&A is forecasted to slowly decrease as a percentage of revenue as top line growth outpaces the growth of fixed costs. Net Working Capital No significant changes are expected within net working capital, and so the line item was forecasted with respect to Abercrombie s historical current ratio. 9
Capital Expenditures & Depreciation Capital Expenditures were forecast to grow modestly throughout the DCF due to a fairly constant rate of store openings throughout the revenue model. Depreciation was then forecasted to trend closely with Capital Expenditures. Beta Abercrombie experienced a large decrease in value around the trough of the recession, yet managed to achieve explosive growth in its equity price in the following two years. As a result of this, a five year monthly and 52 week regression yielded upwardly biased beta estimates of 1.70 and 1.94. A hamada estimation on the other hand produced a beta of 1.15. This estimation was intuitively low, and so a beta of 1.4 was selected, which is an average of the 5 year monthly and Hamada betas. RECOMMENDATION Despite explosive forward looking growth, Abercrombie trades at a modest EV/EBITDA multiple of 11x. This is a result of qualitative factors blinding investors to the significant cash flow growth that will be generated by international expansion. Domestically, investors question potentially declining brand equity, and overlook consensus expectations that show Abercrombie s significant expected bottom line growth over the next four years is greater than that of any of the companies presented in the comparables analysis. Weighting both the relative and DCF valuation at 50% each, Abercrombie has a target price of $93.32, or an undervaluation of 33.5%. 10
APPENDIX 1 COMPARABLES ANALYSIS The University of Oregon Investment Group 35.00% 30.00% 20.00% 15.00% W.A. ($ in millions, except per share data) ANF DECK ZUMZ UA LULU Stock Characteristics Current Price 69.88 96.68 28.91 78.42 101.87 50 Day Moving Avg. 67.83 88.97 27.40 78.13 100.65 200 Day Moving Avg. 68.41 90.15 27.62 78.32 99.74 Beta 1.38 1.68 1.63 1.76 1.65 Size ST Debt 0.00 0.00 0.00 6.90 0.00 LT Debt 68.60 0.00 0.00 9.10 0.00 Cash and Cash Equiv. 826.40 445.20 128.80 203.90 316.30 Minority Interest 0.00 2.70 0.00 0.00 3.90 Preferred Stock 0.00 0.00 0.00 0.00 0.00 Diluted Share Count 89.90 39.30 30.80 51.30 71.90 Market Cap 6282.21 3799.52 890.43 4022.95 7324.45 Enterprise Value 5524.41 3357.02 761.63 3835.05 7012.05 Profitability Margins Gross Margin 57.11% 50.20% 35.60% 49.90% 55.50% EBIT Margin 8.09% 24.88% 7.82% 10.60% 25.60% EBITDA Margin 14.70% 26.10% 11.60% 13.50% 29.10% Net Margin 4.33% 15.81% 5.05% 6.40% 17.10% Credit Metrics Interest Expense (MRQ) 7.30 0.00 0.00 0.60 0.00 Debt/Equity (MRQ) 0.01 0.00 0.00 0.00 0.00 Debt/EBITDA (LTM) 0.14 0.00 0.00 0.11 0.00 Operating Results 0.00 Revenue (LTM) 3468.80 1001.00 478.85 1063.00 722.30 Gross Profit (LTM) 1980.10 515.20 170.40 530.50 400.60 EBITDA (LTM) 502.00 270.20 55.30 143.70 208.60 Operating Cash Flow (LTM) 391.80 139.90 48.70 50.10 180.00 Free Cash Flow (LTM) 230.86 117.40 19.30 19.90 149.60 Valuation EV/EBITDA 11.00 x 12.42 x 13.77 x 26.69 x 33.61 x 18.86 x Metric Implied Price Weight EV/EBITDA 113.74 100.00% Price Target 113.74 Current Price 69.88 Under (Over) Valued 62.77% 11
APPENDIX 2 DISCOUNTED CASH FLOWS ANALYSIS The University of Oregon Investment Group ($ in millions, except per share data) 1 2 3 4 5 6 7 8 9 10 2008A 2009A 2010A 2011 E 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E 2018 E 2019 E 2020 E Total Company Revenue 3,540.30 2,928.60 3,468.80 4,067.76 4,844.72 5,645.77 6,605.07 7,346.70 7,994.19 8,627.15 9,258.44 9,964.26 10,708.86 % Y/Y Growth -17.28% 18.45% 17.27% 19.10% 16.53% 16.99% 11.23% 8.81% 7.92% 7.32% 7.62% 7.47% Cost of Revenue 1,403.92 1,283.80 1,487.90 1,749.14 2,067.71 2,346.67 2,691.40 2,943.45 3,167.46 3,391.64 3,615.27 3,863.35 4,122.88 % Revenue 39.66% 43.84% 42.89% 43.00% 42.68% 41.57% 40.75% 40.06% 39.62% 39.31% 39.05% 38.77% 38.50% Gross Profit 2,136.38 1,644.80 1,980.90 2,318.62 2,777.00 3,299.10 3,913.67 4,403.25 4,826.73 5,235.50 5,643.17 6,100.91 6,585.98 Gross Margin 60.34% 56.16% 57.11% 57.00% 57.32% 58.43% 59.25% 59.94% 60.38% 60.69% 60.95% 61.23% 61.50% Operating Expenses Stores & Distribution Expense 1255.60 1187.20 1309.70 1423.72 1598.76 1806.65 2097.11 2314.21 2498.18 2674.42 2870.12 3088.92 3319.75 % Revenue 35.47% 40.54% 37.76% 35.00% 33.00% 32.00% 31.75% 31.50% 31.25% 31.00% 31.00% 31.00% 31.00% SG & A 419.70 353.30 400.80 488.13 581.37 663.38 759.58 826.50 839.39 862.71 925.84 996.43 1,070.89 % Revenue 11.85% 12.06% 11.55% 12.00% 12.00% 11.75% 11.50% 11.25% 10.50% 10.00% 10.00% 10.00% 10.00% Total Operating Expenses 1,666.50 1,527.00 1,700.40 1,911.85 2,180.12 2,470.02 2,856.69 3,140.72 3,337.57 3,537.13 3,795.96 4,085.35 4,390.63 EBIT 469.88 117.80 280.50 406.78 596.88 829.08 1,056.97 1,262.54 1,489.15 1,698.37 1,847.21 2,015.56 2,195.34 EBIT Margin 13.27% 4.02% 8.09% 10.00% 12.32% 14.68% 16.00% 17.19% 18.63% 19.69% 19.95% 20.23% 20.50% Interest Expense (Income), Net (11.40) (1.60) 3.40 6.51 7.75 9.03 10.57 11.75 12.79 13.80 14.81 15.94 17.13 % Revenue 0.32% 0.05% 0.10% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16% Pre-tax Income 450.68 119.40 228.60 400.27 589.13 820.04 1,046.40 1,250.78 1,476.36 1,684.57 1,832.40 1,999.62 2,178.21 % Revenue 12.73% 4.08% 6.59% 9.84% 12.16% 14.52% 15.84% 17.03% 18.47% 19.53% 19.79% 20.07% 20.34% Less Taxes (Benefit) 178.50 40.60 78.30 140.09 206.20 287.02 366.24 437.77 516.73 589.60 641.34 699.87 762.37 Tax Rate 39.61% 34.00% 34.25% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% Net Income 272.18 78.80 150.30 260.17 382.93 533.03 680.16 813.01 959.64 1,094.97 1,191.06 1,299.75 1,415.84 Net Margin 7.69% 2.69% 4.33% 6.40% 7.90% 9.44% 10.30% 11.07% 12.00% 12.69% 12.86% 13.04% 13.22% Add Back Depreciation and Ammortization 225.33 238.75 229.15 284.74 290.68 282.29 330.25 293.87 319.77 345.09 324.05 348.75 348.04 % Revenue 6.36% 8.15% 6.61% 7.00% 6.00% 5.00% 5.00% 4.00% 4.00% 4.00% 3.50% 3.50% 3.25% Add Back Interest Expense*(1-Tax Rate) (6.88) (1.06) 2.24 4.23 5.04 5.87 6.87 7.64 8.31 8.97 9.63 10.36 11.14 Operating Cash Flow 490.63 316.50 381.69 549.15 678.66 821.19 1,017.29 1,114.52 1,287.72 1,449.03 1,524.73 1,658.86 1,775.01 % Revenue 13.86% 10.81% 11.00% 13.50% 14.01% 14.55% 15.40% 15.17% 16.11% 16.80% 16.47% 16.65% 16.58% Current Assets 1,084.80 1,235.80 1,433.30 1,627.10 1,937.89 2,258.31 2,642.03 2,938.68 3,197.68 3,450.86 3,703.38 3,985.70 4,283.54 % Revenue 30.64% 42.20% 41.32% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% Current Liabilities 449.80 449.40 558.90 610.16 726.71 846.87 990.76 1,102.01 1,199.13 1,294.07 1,388.77 1,494.64 1,606.33 % Revenue 12.71% 15.35% 16.11% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% Net Working Capital 635.00 786.40 874.40 1,016.94 1,211.18 1,411.44 1,651.27 1,836.68 1,998.55 2,156.79 2,314.61 2,491.06 2,677.21 % Revenue 17.94% 26.85% 25.21% Change in Net Working Capital 151.40 88.00 142.54 194.24 200.26 239.83 185.41 161.87 158.24 157.82 176.45 186.15 Capital Expenditures 367.60 175.50 160.90 325.00 300.00 309.00 318.27 327.82 337.65 347.78 358.22 368.96 380.03 % Revenue 10.38% 5.99% 4.64% 7.99% 6.19% 5.47% 4.82% 4.46% 4.22% 4.03% 3.87% 3.70% 3.55% Unlevered Free Cash Flow (10.40) 132.79 81.61 184.42 311.92 459.19 601.29 788.19 943.01 1,008.69 1,113.45 1,208.83 Discounted Unlevered Free Cash Flows 72.24 144.51 216.36 281.94 326.81 379.21 401.61 380.27 371.57 357.09 12
APPENDIX 3 DISCOUNTED CASH FLOWS ANALYSIS ASSUMPTIONS Assumptions for Discounted Free Cash Flows Model Tax Rate 35.00% Terminal Growth Rate 3.00% Risk-Free Rate 3.38% Terminal Value 12489.83 Beta 1.39 PV of Terminal Value 3689.51 Market Risk Premium 7.00% Sum of PV Free Cash Flows 2931.59 % Equity 98.92% Firm Value 6621.10 % Debt 1.08% LT Debt 68.60 Cost of Debt 5.00% Cash 826.40 CAPM 13.08% Equity Value 6552.50 WACC 12.97% Diluted Share Count 89.90 Implied Price 72.89 Current Price 69.88 Under (Over) Valued 4.30% APPENDIX 4 BETA SENSITIVITY ANALYSIS Beta St. Deviation Implied Price Under (Over) Valued 1.7 2.00 55.92-19.98% 1.55 1.00 63.11-9.69% 1.4 0.00 72.89 4.30% 1.25-1.00 82.85 18.56% 1.1-2.00 96.82 38.55% 13
APPENDIX 5 REVENUE MODEL (Millions) 2008A 2009A 2010A 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Domestic Revenue $ 3,220 $ 2,561 $ 2,822 $ 2,964 $ 3,079 $ 3,139 $ 3,265 $ 3,397 $ 3,533 $ 3,675 $ 3,823 $ 3,976 $ 4,135 % Growth -20.45% 10.18% 5.02% 3.88% 1.95% 4.03% 4.02% 4.02% 4.02% 4.01% 4.01% 4.01% Revenue/Store $ 2,862 $ 2,337 $ 2,640 $ 2,877 $ 3,079 $ 3,187 $ 3,298 $ 3,414 $ 3,533 $ 3,657 $ 3,785 $ 3,917 $ 4,054 Stores 1125 1096 1069 1030 1000 985 990 995 1000 1005 1010 1015 1020 Same Store Sales Growth -18.35% 12.97% 9.00% 7.00% 3.50% 3.50% 3.50% 3.50% 3.50% 3.50% 3.50% 3.50% International Revenue $ 265 $ 229 $ 444 $ 848 $ 1,440 $ 2,103 $ 2,839 $ 3,361 $ 3,787 $ 4,188 $ 4,578 $ 5,024 $ 5,486 % Growth -13.26% 93.44% 91.08% 69.78% 46.03% 35.00% 18.42% 12.66% 10.61% 9.30% 9.75% 9.20% Revenue/Store $ 8,195 $ 8,535 $ 9,218 $ 10,140 $ 10,951 $ 11,827 $ 11,591 $ 11,475 $ 11,475 $ 11,590 $ 11,821 $ 12,058 Stores 0 28 52 92 142 192 240 290 330 365 395 425 455 Same Store Sales Growth 4.16% 8.00% 10.00% 8.00% 8.00% -2.00% -1.00% 0.00% 1.00% 2.00% 2.00% Other Revenue $ 132 $ 203 $ 256 $ 326 $ 404 $ 501 $ 589 $ 674 $ 764 $ 858 $ 964 $ 1,087 % Growth 53.70% 26.11% 27.37% 24.03% 24.00% 17.46% 14.53% 13.26% 12.33% 12.38% 12.75% % of Domestic & Int. Sales 4.73% 6.21% 6.71% 7.21% 7.71% 8.21% 8.71% 9.21% 9.71% 10.21% 10.71% 11.30% Total Revenue $ 3,484 $ 2,923 $ 3,469 $ 4,068 $ 4,845 $ 5,646 $ 6,605 $ 7,347 $ 7,994 $ 8,627 $ 9,258 $ 9,964 $ 10,709 % Growth 17.27% 19.10% 16.53% 16.99% 11.23% 8.81% 7.92% 7.32% 7.62% 7.47% 14
APPENDIX 6 GROSS MARGIN MODEL Segment Margins 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E International 67.00% 66.00% 66.00% 66.00% 66.00% 66.00% 66.00% 66.00% 66.00% 66.00% Domestic 52.00% 51.00% 51.00% 51.00% 51.00% 51.00% 51.00% 51.00% 51.00% 51.00% Other 82.84% 82.00% 82.00% 82.00% 82.00% 82.00% 82.00% 82.00% 82.00% 82.00% Segment Percentage of Revenue International 20.40% 28.23% 34.77% 39.33% 43.00% 45.08% 46.28% 47.19% 48.19% 49.02% Domestic 73.31% 65.04% 58.07% 53.08% 48.98% 46.48% 44.87% 43.54% 42.14% 40.83% Other 6.29% 6.73% 7.16% 7.59% 8.02% 8.44% 8.85% 9.27% 9.68% 10.15% Gross Margin 57.00% 57.32% 58.43% 59.25% 59.94% 60.38% 60.69% 60.95% 61.23% 61.50% APPENDIX 7 HAMADA BETA REGRESSION Company Beta D/E DECK 1.68 0.00% AEO 0.92 1.40% UA 1.76 6.00% LULU 1.65 0.00% JWN 1.58 152.90% BEBE 1.03 0.00% ZUMZ 1.62 2.50% RUE 1.31 124.40% GAP 0.95 3.10% RL 1.36 18.70% Mean 1.39 30.90% Pure Business Beta 1.39 Sample D/E 30.90% Unlevered Beta 1.15 15
APPENDIX 8 SOURCES Abercrombie Investor Relations Bank of America Merrill Lynch Research Barrons CBS News http://www.sec.gov Standard and Poor s Industry Reports Yahoo! Finance FactSet IBISworld Reuters 16