Abercrombie & Fitch’s Dismal Q4 Results Raise Concerns Around Revival Strategies

There seems to be no respite for Abercrombie & Fitch (NYSE:ANF), even though it’s trying hard to win customers back. Bogged down by weak demand for both  Hollister and ANF, a decline in foot traffic, weak growth in online sales and negative currency headwinds, the company’s Q4 fiscal 2014 revenues fell 14% to $1.12 billion and non-GAAP net income decreased by over 20% to $80.8 million. Abercrombie’s revenue decline came from a 13% fall in comparable store sales, partially offset by 1% rise in direct-to-consumer revenues. Also, the retailer had a fewer number of stores operational at the end of Q4 fiscal 2014 as compared to the year ago period, which contributed to the revenue decline.

By geographies, Abercrombie’s revenues fell 10% in the U.S. and 20% in international markets. While declining store traffic and weak customer response to product offerings were responsible for the retailer’s domestic performance, negative currency headwinds suppressed its international revenues. Abercrombie stated that strengthening dollar had a negative impact of 3% on its results, while the remaining decline can be attributed to its long standing problems.

For the full year, Abercrombie reported a 9% decrease in its revenues, a 12% decline in comparable store sales and 10% increase in direct-to-consumer revenues. Its earnings per share declined close to 20% year over year to $1.54, barely meeting its revised guidance $1.52-$1.65. ^[1] It is worth noting that the retailer had slashed its full year EPS guidance from $2.15-$2.35 at the end of the third quarter. Following these results, Abercrombie’s stock fell a sharp 15%, raising questions about the effectiveness of its revival strategies. The company is phasing out its logo business, testing new storefronts and pricing for Hollister, investing heavily in direct-to-consumer and omni-channel retailing, and consolidating its under-performing store network. While it can be said that Abercrombie is headed in the right direction with these strategies, it still does not have any sort of results to show for it.

Our price estimate for Abercrombie & Fitch stands at $37.30, which is about 80% above the current market price. However, we are in the process of updating our model in light of the recent earnings release.

See our complete analysis for Abercrombie & Fitch

Abercrombie Continues To Lose Customers

The present scenario in the U.S. is such that buyers are reluctant to spend much on basic logo merchandise from specialty brands such as Abercrombie, American Eagle Outfitters (NYSE:AEO) and Aeropostale (NYSE:ARO). Instead, they prefer cheaper private labels from Wal-Mart (NYSE:WMT), Target (NYSE:TGT) and J.C. Penny for their basic apparel needs. However, they are prepared to spend a higher amount on fashion-forward merchandise, that are being offered by brands such as Zara, Forever 21 and H&M. Since Abercrombie’s product portfolio mainly had basic logo products and a limited fashion variety, it has lost a number of its customer during the last couple of years.

Last year, the retailer decided to phase out its logo business within 12 months to make way for fresh fashion inventory. However, while the company has been aggressive in reducing its logo inventory, it hasn’t been equally proactive in replacing it with fashion-forward inventory. As a result, for the last couple of quarters, basic as well as fashion inventory in Abercrombie stores has been limited, which explains why it continued to lose customers.

Trying to justify this loss, the management reiterated during the recent earnings call that the company is in its transition phase and ongoing strategies will take some time to show meaningful results. Executive Chairman Arthur Martinez said that this transition will trouble the company for another couple of quarters, but will help the brand in the long run. ^[2] However, there is no certainty that customers will get enough incentives to return to Abercrombie, even if the retailer successfully revamps its portfolio.

Efforts To Entice Customers May Have A Marginal Positive Impact

Abercrombie’s brand image has taken a beating over the past couple of years due to several unwanted controversies and criticism for failed strategies. Couple that with a sluggish transition in product portfolio and a near term turnaround seems unlikely. While things won’t change for the company overnight, its strategies to improve the shopping experience may leave a positive impression on customers.

Abercrombie has been testing new storefronts for its Hollister brand, and the initial rollout in 50 U.S. stores and four U.K. stores has been pleasing. This format will be added to another 50 stores in 2015. Also, the company has come up with a new store management incentive plan, which encourages store and district managers to strive for better store performance. The retailer’s outlet format in the U.S. saw 20% comparable store sales growth during the fourth quarter, which should encourage it to expand this further. Abercrombie plans to open 11 such stores in 2015.

However, all these strategies are small scale efforts and they will not help Abercrombie unless its merchandise portfolio improves considerably and it finds a way to better  respond to the ongoing online shift.

Resorting to Direct-To-Consumer And Omni-Channel Won’t Do Much Good

Similar to most participants in the retail industry, Abercrombie has been aggressively deploying its omni-channel strategies. The retailer now ships directly from 375 stores and its order in-store service is live in over 650 U.S. stores. This figure will continue to increase in 2015, and the company has several omni-channel strategies planned for Europe as well.

However, the fact remains that direct-to-consumer business constitutes a very small fraction of the company’s overall revenues. Even with rapid growth in online revenues and continued store consolidation, this channel is unlikely to become strong enough to drive overall results in the foreseeable future. Moreover, the online industry in itself is very competitive and Abercrombie’s performance in this arena has not been outstanding.

For instance in 2014, Abercrombie’s comparable store sales fell 12% and after factoring in 10% growth in online sales (which is not too good considering the industry standards) the fall in comparable sales could come down by only 2 percentage points. Undoubtedly, online growth is having a notable offsetting impact on Abercrombie’s revenue decline, but the company cannot rely on this channel alone for its future growth. It needs to get its store business right.

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1. Abercrombie & Fitch Reports Fourth Quarter Results, Abercrombie & Fitch, Mar 4 2015 [↩]
2. Abercrombie & Fitch’s Q4 fiscal 2014 earnings transcript, Mar 4 2015 [↩]