Abercrombie & Fitch’s Business Transition Will Weigh On Its Q1 Results

Abercrombie & Fitch (NYSE:ANF) is scheduled to release it Q1 fiscal 2015 earnings on May 28th. Given its weak product portfolio, strategy of aggressively phasing out logo products and an industry-wide decline in foot traffic, we expect another quarter of dismal results. Abercrombie is among those retailers in the U.S. whose persistent reliance on basic logo merchandise has driven customers away to fast-fashion brands. The brand offers products at relatively higher prices than other specialty apparel retailers such as Aeropostale (NYSE:ARO) and American Eagle Outfitters (NYSE:AEO), which has again worked against it. Rather than buying premium logo merchandise from Abecrombie, buyers prefer to spend on equally expensive but high on fashion products from Zara and Forever 21. Buyers with a smaller budget prefer to shop at relatively affordable places such as American Eagle and Urban Outfitters (NASDAQ:URBN). Those who are not too concerned about the brand are content with buying private labels at department stores and general merchandise retailers.

Though Abercrombie had identified this trend and was proactively looking to overhaul its merchandise portfolio, its sales have plummeted during this transition. During the last quarterly earnings call, Executive Chairman, Arthur Martinez said that business transition will trouble the company for another couple of quarters, but will help the brand in the long run. It is thus almost certain that Abercrombie will report weak results yet again. Moreover, the industry-wide decline in foot traffic on account of the ongoing online shift likely made things worse for the company. Even though Abercrombie’s direct-to-consumer sales are growing, they aren’t contributing much to overall growth due to the channel’s small size. This trend will be visible again in the upcoming results.

Our price estimate for Abercrombie & Fitch stands at $37.30, which is about 60% above the current market price.

See our complete analysis for Abercrombie & Fitch

Portfolio Transition To Weigh On Growth

There was a time when Abercrombie’s logo on basic t-shirts and jeans was enough to attract customers, but it is no longer the case. Over the past two to three years, U.S. shoppers have shown great interest in fashion-forward products from Zara, Forever 21 and H&M, but little affinity towards logo branded basic products from Abercrombie. As a result, the company’s revenues have declined significantly, since it persistently relied on the logo business hoping that its iconic brand image would eventually bring customers back.

However, given that U.S. buyers have shunned basic logo products altogether irrespective of the brand, Abercrombie decided to aggressively transition its portfolio from basic logo products to non-logo fashion products. Last year, in an earnings announcement, the management stated that they will reduce their logo business to “almost nothing” within 12 months and replace it with fashion-forward inventory. While Abercrombie has progressed very well in reducing its logo protfolio, it hasn’t been as proactive in replacing that with on-trend fashion inventory and both these factors have weighed heavily on sales. We expect Q1 to be no different, though there might be some signs of improvement in individual categories’ performances with improved fashion content.

Online Growth Wont Help

Similar to most participants in the retail industry, Abercrombie has seen sturdy growth in its online revenues and has been aggressively deploying its omni-channel strategies. 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, let alone Q1 fiscal 2015. 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 noticeable offsetting impact on Abercrombie’s revenue decline, but it is not significant enough.

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