A Small Bet on a Fallen Retail Stock

Investors got a good picture of the current state of the retailing space last week thanks to a flurry of second-quarter results that flooded across the wires. To put a kind spin on it, results were "mixed" the quarter. 

Some retail names such as Best Buy (BBY) managed to step over low expectations. However, others like Foot Locker FL and Ulta Beauty ULTA were not quite as fortunate. Dollar General DG was crushed on Thursday after posting tepid Q2 numbers and providing dismal guidance. The stock fell 32% following those results, the worst one-day performance in its long history on the market. Dollar General's turnaround efforts seem to be more challenging than previously thought and Walmart WMT also appears to be eating its lunch to some degree.

I did not buy the dips in any of these names. However, I did establish a new position in one retail stock this week, clothing retailer Abercrombie & Fitch ANF, via covered call orders. The stock sank 19% in trading Wednesday following Q2 results that came out about two hours before the opening bell. The extent of the decline seemed to be a bit of a knee-jerk reaction to me, so I dove in on this potential falling knife using a simple covered call strategy for additional downside risk mitigation.

There was nothing wrong with Abercrombie’s actual second quarter numbers. The retailer delivered earnings of $2.50 a share, more than a quarter a share above expectations. Operating margins rose 590 bps to 15.5%. Revenues also climbed an impressive 21% on a year-over-year basis to $1.13 billion, some $40 million north of the analyst firm consensus. Leadership bumped up slightly its FY2024 growth forecast to 12% to 13% over FY2023. However, that was a bit light of what the Street was expecting, which was the key factor in the sell-off in the stock on Wednesday.

ANF shares have rebounded a bit since their nadir on Wednesday, but there still seems a solid trade here. Abercrombie is seeing some of the highest comp-store growth in the industry with brand names like Hollister. The company has also plenty of global growth opportunities and has a pristine balance that should end fiscal year 2024 with around $1.2 billion in cash and no long-term debt. 

Abercrombie's market cap is currently around $7.3 billion and it should buy back approximately $100 million worth of stokc in the second half of the year, according to Citigroup, which also sees mid-teens average annual earnings growth for this retailer through FY 2028.

Best of all, the shares are more than reasonably priced, trading at under 14 times earnings — and cheaper still if one factors in the net cash on Abercrombie’s balance sheet.

Option Strategy

This is how one can execute a covered call position in ANF. 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 February $140 call strikes, fashion a covered call order with a net debit in the $122.50 to $123.00 a share range (net stock price - option premium). 

This strategy provides downside protection of approximately 16% with upside potential of some 14% even if this stock falls roughly 5% from here over the next six months. 

At the time of publication, Jensen was long ANF.