Abercrombie & Fitch Falls On Weak Results And Downbeat Guidance

Abercrombie & Fitch‘s (NYSE:ANF) shares slumped 18% after it reported disappointing Q2 fiscal 2013 results and lowered its guidance for the third quarter. The company’s comparable store sales fell by 10% in the U.S. and 7% in international markets. Apart from the industry weakness, the weakness in the women’s business and a shift in shopping trends also contributed to the decline. The recently concluded quarter has been rough for a number of retailers due to weak consumer spending and high unemployment rate.

Abercrombie expects its comparable store sales for the third quarter to be weaker than that in the second quarter. ^[1] The company didn’t provide guidance beyond the third quarter stating that it does not have clear visibility on the uncertain store traffic trends. We believe that the chances of Abercrombie’s revival in the near term are slim due to economic headwinds in the U.S., a fickle customer base and inventory troubles. However, the company’s direct-to-consumer business remains strong and its Chinese business is showing promise.

See our complete analysis for Abercrombie & Fitch

Why A Near Term Revival Is Unlikely?

Most of Abercrombie’s customers are teenagers and are dependent on their parents for money. Since the payroll tax hike and high unemployment rate have hurt consumer spending in the U.S., teenage shoppers are left with less to spend. The unemployment rate in the U.S. teenage segment (23.7% July) is one of the highest among large economies, and so teens aren’t making up this shortfall through their own earnings. ^{[2] [3]}

Additionally, a fickle customer base has also hurt the retailer’s results as customers move to low-cost, fast-fashion brands such as Zara, Forever 21 and H&M. ^{[4] [1]} They are also diverting their spending to other categories such as electronics. Abercrombie’s brand loyalty appears to be low and too much negative media does not help. The company has recently faced criticism over its management’s comments, discriminatory staffing policies and a t-shirt insulting popular singer Taylor Swift (read Abercrombie & Fitch Engulfed By Inventory Issues & Negative Press).

Abercrombie has faced shortage and surplus inventory issues in the recent past, and its inventory management remains questionable. Although the company managed to finish the second quarter with clean stock levels, we remain skeptical about how the company fares during the third quarter as far as its inventory is concerned. In its recent earnings call, the retailer stated that it is planning its inventory conservatively for the remainder of the year. ^[1] Even if the store traffic improves towards the end, Abercrombie might not be in a good position to respond.

Direct-To-Consumer Business Will Fuel Long-Term Growth

Abercrombie’s direct-to-consumer business (mainly e-commerce) has grown at an average annual rate of around 35% for the last three years. Although revenues declined by 10% in the first quarter, direct sales grew by 21% in Q2 fiscal 2013 despite overall weakness. Currently this channel accounts for about 16% of Abercrombie’s net revenues, up from 9% in 2008. Given the optimistic outlook for online apparel retail in the U.S. and Europe, we expect the retailer’s e-commerce business to continue its momentum. ^{[5] [6]}

Abercrombie is making some efforts of its own to strengthen its e-commerce channel. In 2010, it entered m-commerce using Digby’s mobile commerce platform and made its websites available on all Internet-enabled mobile devices allowing users to browse and purchase with convenience. ^[7] During the same year, the retailer also launched an iPad app. Although m-commerce is still a small platform in the U.S., it has seen triple-digit growth in recent years. Bank of America estimates retail sales through smartphones and tablets in the U.S. and Europe to increase from $25 billion in 2012 to $67 billion in 2015. ^[8] Like other players in the industry, Abercrombie is also exploring omni-channel possibilities to attract customers irrespective of their preferred shopping channel. ^[1]

China Shows Promise

With rising disposable income, a booming middle class and growing urbanization, China has become the second largest apparel market in the world. Total apparel sales in the region grew from $110 billion in 2009 to $140 billion in 2012, and are expected to reach $220 billion by 2016. ^{[9] [10]} Within the market, the casual wear segment has been growing the fastest as Chinese shoppers are shifting more to western styles for clothing. ^[9]

Lately, a number of players have entered China and have seen tremendous success from the outset. Abercrombie opened its first store in China in 2011 and has been growing rapidly since then. In Q2 fiscal 2013, the retailer’s comparable store sales in the region increased by a staggering 60%. ^[1] Although the company is still at a nascent stage in China, the long-term opportunity cannot be ignored.

Our price estimate for Abercrombie & Fitch stands at $49, which is significantly premium to the market price. However, we are in the process of updating the model in the light of recent earnings.

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

1. Abercrombie & Fitch’s Q2 fiscal 2013 earnings transcript, Aug 22 2013 [↩] [↩] [↩] [↩] [↩]
2. Teen Retailers Could Be In For Rough Back-To-School Season, The Wall Street Journal, Aug 6 2013 [↩]
3. America’s Youth Nonemployment Rate Is One Of The Worst Of Wealthy, Large Economies, Huffington Post, May 5 2013 [↩]
4. Electronics, int’l ‘fast-fashion’ rivals squeeze top US teen chains, GMA News, Aug 22 2013 [↩]
5. Retail Ecommerce Set to Keep a Pace Through 2017, eMarketer, Apr 24 2013 [↩]
6. US Online Retail Sales To Reach $370B By 2017, EUR191B in Europe, Forbes, Mar 13 2013 [↩]
7. Abercrombie & Fitch And Hollister Co. Go Mobile With Digby, Digby, Jan 26 2010 [↩]
8. BII Report: Why Mobile Commerce Is Set To Explode, Business Insider, Jan 10 2013 [↩]
9. From Mao to Wao: Winning in China’s Booming Apparel Industry, McKinsey, Jan 2011 [↩] [↩]
10. China’s apparel retail market: $218 industry by 2016, Trans World News, Aug 3 2013 [↩]