Three Factors Driving Abercrombie & Fitch’s Growth

After struggling through most of last year, Abercrombie & Fitch‘s (NYSE:ANF) shares surged by almost 30% in November 2012, after its earnings beat market expectations. The retailer posted good results fueled by fewer markdowns and controlled expansion.

Key drivers to our estimates include growth in its e-commerce business, a focus on improving AUR (average unit retail or average price per unit) and enhancing customer engagement. The consolidation of underperforming ANF stores in the U.S. and Hollister’s expansion abroad will also help the retailer’s cause. (Read: Abercrombie & Fitch’s U.S. Consolidation And Targeted Expansion Abroad Will Help Profitability, ANF Has Upside Potential With Hollister’s Expansion Abroad)

See our complete analysis for Abercrombie & Fitch

Direct-To-Consumer Business

Online apparel sales in the U.S. have been increasing at a rapid pace due to growing Internet usage and the proliferation of smartphones and tablets. Major players such as Urban Outfitters (NASDAQ:URBN), American Eagle Outfitters (NYSE:AEO) and Gap (NYSE:GPS) have thrived from this trend and Abercrombie is no different. ^[1] The retailer’s direct-to-consumer revenue growth averaged nearly 35% annually between 2010 and 2012. ^[2] We expect this growth to continue in the future due to the positive outlook of the online retail market in the U.S. and Abercrombie’s launch of its e-commerce sites for international markets.

Forrester forecasts that the U.S. online retail sales will amount to $262 billion in 2013 (an increase of 13% over 2012) and reach $370 billion by 2017. ^[3] Based on the historical trends, we expect online apparel sales growth to remain faster than the overall online retail sales growth in the U.S. (Read: How Abercrombie & Fitch’s Online Revenue Growth Impacts Its Stock Value) In addition, Abercrombie launched its e-commerce site in Europe in 2012, and we expect the retailer to add more markets to this list in the future.

The direct to consumer segment accounts for about 40% of the company’s value, according to our estimates.

Improving Average Unit Retail (AUR)

Abercrombie has faced difficulty in managing its inventory in the recent past. This resulted in excessive promotional discounts leading to a decline in average unit retail (average price per unit). This not only impacted the retailer’s comparable store sales but also weighed on its margins. Recently, the company created a cross-functional team with a senior level leader to specifically work on identifying ways to improve average prices. ^[4] The most important factor on this front is inventory management. If Abercrombie can maintain proper inventory levels, it can operate with fewer promotional discounts, leading to an increase in average price per unit.

Abercrombie is looking to increase its inventory at a much slower pace than its sales growth. Low carryover of fall inventory in Q4 fiscal 2012, and 35% lower inventory (as compared Q4 fiscal 2011) at the end of the same quarter were indicative of this effort. ^[4] This helped Abercrombie in reducing the number of markdowns and improve its margins. The retailer is also increasing its vendor collaborations to utilize its supply chain expertise during product development cycle, which will help in timely delivery of merchandise. ^[4] Ultimately, this should lead to an increase in full priced sales resulting in better AUR. Abercrombie has a diverse supply chain with more than 150 vendors across 20 countries with no single vendor accounting for more than 10% of its inventory. ^[2] This maintains the supply chain’s efficiency even if some vendors fail to respond in a timely manner.

Better Customer Engagement

Abercrombie recently initiated its first global market research study to better understand customers and competitors in different markets such as North America, Europe and Asia. ^[4] Also, the retailer launched a loyalty club program for its ANF brand last year that offers discounts, gift certificates and other rewards. It provides free shipping for online orders and access to exclusive music videos and photo galleries on its website. ^[5]

In the initial stages of this program, more than 750,000 customers signed up and started buying more than the regular customers. Towards the end of the fourth quarter, this figure increased to more than 1.5 million. This is in addition to 3.5 million existing customer contacts. Such programs will help Abercrombie in keeping the customers interested in its brands. ^[4] The company is seeing gains from its social media presence as well as fan’s of Hollister’s Facebook (NASDAQ:FB) page exceeded 10 million. ^[6] Moreover, the brand was among the top five non-paid trending topics on Twitter during Black Friday for the second consecutive year. ^[4] We believe this strong connection with its core customers through social media sites like Facebook and Twitter leads to better customer engagement that will help drive more online sales, which bodes well for the company’s outlook.

Our price estimate for Abercrombie & Fitch stands at $51, which is in line with the market price. However should these factors lead to faster sales growth than we expect, we could see upside to our estimates. For example if Internet and catalog revenues are 20% higher by the end of our forecast period, this leads to 10% upside in our estimates.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Companies’ SEC filings [↩]
2. Abercrombie & Fitch’s SEC filings [↩] [↩]
3. U.S. Online Retail Sales To Reach $370B by 2017, Forbes, Mar 14 2013 [↩]
4. Abercrombie & Fitch Q4 fiscal 2012 earnings transcript, Feb 22 2013 [↩] [↩] [↩] [↩] [↩] [↩]
5. Abercrombie & Fitch launches club loyalty promising, exclusive online photos and other content, Business Journal, Aug 15 2012 [↩]
6. Hollister’s Facebook page [↩]