Abercrombie & Fitch Rises On Latent Signs Of Recovery

Abercrombie & Fitch (NYSE:ANF) recently reported its Q1 fiscal 2015 results and as expected, the effects of its business transition weighed heavily on its growth. The retailer’s net sales fell 14% to $709 million, while its comparable sales were down 8% and losses doubled to $63.2 million. Yet, the company’s shares rose  13% once the market opened as investors showed ample faith in Abercrombie’s turnaround efforts. The comparable sales decline was marginally lower than analysts’ expectations of 9%, thanks to a moderate increase in full priced sales, which contributed to investor optimism. ^[1] In terms of profitability, a significant increase in Abercrombie’s losses was mainly attributable to charges related to its business transition efforts, and on an adjusted basis overall bottomline growth was better than it appeared.

Abercrombie is in the process of overhauling its business by changing its long standing strategies to align itself with the prevailing market conditions. It is clearing its basic logo merchandise portfolio with heavy discounting to make way for trend and fashion relevant products. During the first quarter, in addition of inventory clearing promotions, the retailer spent an additional $26.9 million to clear merchandise that wasn’t selling, some of which dated back to 2013. This brought gross profit margin down to 58.0% from 62.2% in the same quarter last year.

Our price estimate for Abercrombie & Fitch stands at $37.30, which is about 35% 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 has been working on removing basic logo merchandise from its portfolio for some time now and most of it is now out of the way. During Q1, the company said that it was able to usher a higher proportion of full priced sales, as it had a higher inventory of fashion merchandise compared to before. The biggest visible impact was at Hollister, where the comparable sales decline came down to 6% in Q1, while it was over 11% in Q4 fiscal 2014. For Abercrombie’s mainline brand, a 9% decline in comparable sales suggested thatthe  merchandise portfolio transition here wasn’t as effective as Hollister. Nevertheless, the company has laid down a path of recovery for its namesake brand. It is reinforcing the talent team, adding the latest trends to its offering, more effectively managing its inventory, and (most importantly) trying for a balanced portfolio of fashion, classics and logos. ^[2] With time, we believe that these efforts will yield some fruitful results. Fortunately for the company, investors seem to have the same idea.

Although Abercrombie clocked up significant losses during the quarter, there were several non-recurring charges related to clearing unsold inventory and investments in revamping in-store environment. The retailer’s stores and distribution expenses as percentage of revenues increased to 55.2% in Q1 this year as compared to 50.8% in the year ago period. Most of it came from higher investments in stores. Once known for its “sexy” image, Abercrombie is now looking to do away with that tag, realizing that it is no longer helping its sales, but is in fact impairing its brand image. The company is investing to overhaul its in-store layout, which previously reflected its “sex appeal”. The retailer is no longer hiring shirtless models for its store staff anymore, which will be more relevant to its updated layout. Historically, Abercrombie did not offer clothes for plus-sized women in order to keep its iconic image intact, but it began targeting this market a while back. The company has come to terms with the fact that to survive in the relentlessly competitive U.S. apparel market, it needs to adapt with changing consumer views and preferences.

While Abercrombie’s growth still remains significantly negative, the fact cannot be ignored that it is the first among its peers to take such formidable steps to transition its business. Others are still employing comparatively softer strategies, with careful risk-reward assessments. However, the risks involved in Abercrombie’s revival strategies are high, as there is no certainty that buyers will respond positively to a different Abercrombie, once it is done with its business transition.

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1. Abercrombie & Fitch surges, but don’t call it a miracle at the mall yet, CNN Money, May 28 2015 [↩]
2. Abercrombie & Fitch’s Q1 fiscal 2015 earnings transcript, May 28 2015 [↩]