Abercrombie & Fitch’s Shares Rise On Better-Than-Expected Profits And Guidance

Abercrombie & Fitch‘s (NYSE:ANF) struggle continued in Q4 fiscal 2013 as its revenues and comparable store sales (including e-commerce) declined by 12% and 8% respectively. However, the rate of comparable store sales decline was lower than what the company saw in preceding quarters. This is attributable to Abercrombie’s 25% e-commerce sales growth during the holiday season.

Although the retailer’s sales still fell short of Wall Street’s expectations, its profits were able to beat consensus estimates. Excluding restructuring and other one time charges, Abercrombie’s earnings per share for the fourth quarter were $1.34, which was significantly more than the market expectation of $1.03. The company even issued encouraging earnings per share guidance for 2014 in the range of $2.15-$2.35, with the midpoint ($2.25) a bit below the analysts’ estimate of $2.31. Also, Abercrombie approved a $150 million aggressive share buyback plan to be implemented in the first quarter of fiscal 2014. As a result of these factors, the company’s stock price rose by more than 10%.

Abercrombie is now looking to revamp its product portfolio to make it more trend- and season-relevant, while keeping its prices affordable. Although this could have a negative impact on the retailer’s comparable store sales, it can be helpful in driving store traffic. The company is also employing several strategies to reduce costs and increase profitability. Additionally, Abercrombie is continuing its investments in the direct-to-consumer channel, which should help it sustain the healthy online revenue growth. We believe that the company’s better-than-expected results in the fourth quarter and its recovery efforts for the current fiscal year should address rising investor concerns to a certain extent.

Our price estimate for Abercrombie & Fitch stands at $37.62, implying a discount of about 5% to the market price. However, we’re in the process of updating our model in light of the recent earnings release.

See our complete analysis for Abercrombie & Fitch

Abercrombie Is Also Looking To Get Fast-Fashion and Low-Cost

Taking cue from successful low-cost fast-fashion brands such Gap Inc (NYSE:GPS), Urban Outfitters (NASDAQ:URBN), Forever 21, H&M etc., Abercrombie is looking to revamp its product portfolio. The company is working on improving its designs, shortening lead times and increasing style differentiation to offer a better variety of fashion assortments and remain responsive to changing trends. Abercrombie recently hired First Insight Inc to test its products much earlier in the product development cycle, and plan their launch accordingly. The retailer stated that it is now testing 100% of its assortments, that will enable it to better understand customer tastes, and reduce the risks related to its fashion launches. The company will be employing a vertical organization structure for categories such as planning, merchandising and design for each individual brand. Along with brand differentiation, this should help Abercrombie effectively address the needs of its business. Additionally, the company is utilizing new fabric platforming techniques to increase its speed to market. It will also start including vendor designed products in its merchandise mix in the first quarter of fiscal 2014. ^[1]

Being a relatively expensive brand, Abercrombie struggled to attract customers throughout last year on account of cautious consumer spending. The company is now planning to reduce its average unit costs to bring back its teenage customers, who eluded the retailer for other affordable brands. However, lower prices will weigh on Abercrombie’s comparable store sales growth. The company expects a high-single digit decline in its comparable sales during the current year. Nevertheless, we believe that Abercrombie should take this step towards the revival of its business.

The Company Is Looking To Save Costs

Abercrombie’s gross margins for the fourth quarter shrunk by 440 basis points as compared to the same quarter last year. Heavy promotional activities during the holiday season was the main reason behind the margin decline. This trend might persist in the near future given the uncertain economic environment in the U.S. Moreover, the retailer’s plan to reduce its product prices threatens to push its margins lower. As a result, Abercrombie is looking to increase its cost savings.

The company is planning to reduce the cost of its clothing, which can help it offer products at lower prices without much pressure on margins. The closure of Abercrombie’s intimate brand Gilly Hicks is also expected to have a certain positive impact on its cost savings. The retailer closed 16 Gilly Hicks stores during Q4 and is expected to shut the remaining ones in the first quarter. In its recent earnings call, the company stated that it saved nearly $25 million during the fourth quarter as a part of its profit improvement initiative. For fiscal 2014, Abercrombie expects to save $175 million in areas such as store repairs and maintenance, store packaging, IT, supplies, and corporate overhead. Higher profitability will result in better cash flow generation, which can have a positive impact on the retailer’s stock price.

Online Growth To Continue

Abercrombie’s direct-to-consumer business registered strong growth during the holiday quarter, which is likely to continue this year. The retailer’s direct revenue growth picked up to 24% during the fourth quarter after a relatively slow Q3. Overall, Abercrombie’s e-commerce revenues increased by just 11% in 2013, but the company forecasts it to grow by 20% in 2014. The management stated that investments made in the online channel have resulted in a significant rise in conversion rate.

During 2014, the retailer is planning to bolster its web offerings by adding exclusive products. Abercrombie has allocated $200 million for capital expenditure in 2014, which will be mainly utilized for the development of the direct-to-consumer channel as well as IT systems. Investments in the direct channel include a distribution center in New Albany, order management system upgrades, mobile capabilities advancements, and expanding payment options. ^[1] The proportion of Abercombie’s direct revenues in its net sales increased steadily from 10% in 2009 to 16% in 2012. However, this figure surged to 25% during the holiday season, justifying Abercrombie’s investments on this front.

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1. Abercrombie & Fitch Q4 fiscal 2013 earnings transcript, Feb 26 2014 [↩] [↩]