A Scenario That Can Add To Abercrombie & Fitch’s Value

Abercrombie & Fitch (NYSE:ANF) has had a number of problems over the past four years that have impacted its growth significantly. Ranging from poor inventory management to bad issues in the press, these problems have driven customers to other brands. Looking at the last couple of years in particular, persistent reliance on basic logo merchandise, even when buyers across the industry favored fashion forward merchandise, have troubled the company. Its comparable store sales fell significantly and several unwanted controversies only added to the difficulties.

However, Abercrombie is now looking to overhaul its product portfolio by transitioning out the entire basic logo inventory and replacing it with fashion forward products. This should put the company in a better position to gradually bring customers back. Though there will be some increase in average unit retail going forward, thanks to better products on offer, Abercrombie’s recovery is likely to be slow due to its weak image and intense competition across all the segments of the apparel market. Therefore, we have forecast a marginal rebound in revenue per square foot for the retailer’s brands — Abercrombie & Fitch, Hollister and abercrombie kids.

Our price estimate for Abercrombie & Fitch stands at $29.44, which is about 30% above the current market price.

See our complete analysis for Abercrombie & Fitch

However, consider a scenario where Abercrombie effectively turns around it merchandise portfolio and successfully positions itself close to the league of fast-fashion players such as Zara and Forever 21. The transition of a casual apparel retailer into a fast-fashion company may appear somewhat unrealistic, but Abercrombie is aggressively progressing towards this goal and the potential for its success will become apparent in the near-future. In case the company draws better than expected customer response towards its product offering across brands and channels, there exists the potential for significant upside in its value estimates.

Better-Than-Expected Recovery In Average Prices (+15%)

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 fiscal 2015, the company had 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 that the  merchandise portfolio transition here wasn’t as effective as at 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. ^[1]

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 models for its store staff anymore, which will be more consistent with 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. With time, we believe that these efforts will yield some fruitful results. In case these results exceed our expectations, the following scenario would unfold.

Hollister’s revenue per square feet declined from $475 in 2012 to $356 in 2014, and we had forecast the figure to rebound to only $366 over the next five-six years, backed by the aforementioned factors, partially offset by growing competition. For the scenario under discussion, we change our long-term estimate from $366 to $400. A similar historical trend was visible for Abercrombie & Fitch, as its revenue per square feet had declined $518 in 2012 to $416 in 2014, with a forecast to only $416 over the next five-six years. We adjust the figure to $460 instead. Though the transition in the  merchandise portfolio was mainly targeted at teenagers and young adults, we expect the company to work equally proactively on its kids business as well. For abercrombie kids, we increase our long term forecast from $380 to $400. Simultaneously, we raise our forecast for e-commerce revenues from $1.38 billion at the end of 2021 to $1.60 billion. These adjustments cumulatively result in a potential upside of almost 15% in our price estimate.

While it is almost certain that Abercrombie will not be able to relive its golden days when it was the most sought after apparel brand, the aforementioned scenario is very much a possibility. Predicting buyer response is difficult, but Abercrombie has realized that their interest lies with fashion infused products, and that is where it is pushing. Our revised long term forecast for revenue per square feet still remains well below its 2012 levels and therefore, it is achievable with a fashion forward merchandise portfolio and disciplined inventory control.

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1. Abercrombie & Fitch’s Q1 Fiscal 2015 Earnings Transcript, May 28 2015 [↩]