Abercrombie’s Shares Look Considerably Undervalued After Tanking 30% On Weak Q2 Outlook

Abercrombie & Fitch (NYSE: ANF) reported a mixed performance for the first quarter. The apparel retailer’s shares tanked about 30% due to lower-than-expected same-store sales coupled with a weak earnings guidance for Q2. Although, the company’s same-store sales were up 1% during the quarter, this key metric for the company’s largest brand, Hollister’s, increased only 2% against street expectations of 3.3%. Overall, net sales of Abercrombie grew by 0.7% (y-o-y) to $734 million while the company reported a net loss of $0.29 per share, narrower than the expected adjusted loss of $0.43 per share.

However, we believe that investors overreacted to Abercrombie’s Q2 guidance, which includes a one-time charge of $45 million linked to the closing of 3 of its flagship stores. Also, it must be kept in mind that the first quarter has been a notably weak period for the apparel industry as a whole. That is why we retain the $27 Trefis price estimate for Abercrombie’s stock. Our estimate is roughly 55% ahead of the current market price. We have summarized our key expectations from the earnings announcement in our interactive dashboard, How Did Abercrombie & Fitch Fare In Q1 and What Can We Expect From Full-Year 2019?  In addition, here is more Trefis Textiles, Apparel and Luxury Good Industry Data.

A Quick Look at Abercrombie & Fitch’s Revenue Sources

Abercrombie & Fitch reported $3.6 billion in Total Revenues in Fiscal 2018. This included 2 revenue streams:

• Abercrombie: $1.4 billion in FY 2018 (40% of Total Revenues). This brand is a specialty retailer of high-quality apparel and accessories for men and women.
• Hollister: $2.2 billion in FY 2018 (60% of Total Revenues). Hollister is focused on teens globally and also includes the intimates brand Gilly Hicks.

Key Takeaways From Abercrombie’s Fiscal Q1

Digital Sales Continues To Thrive

• Digital channel has been pivotal to Abercrombie’s growth over the recent quarters. There has been a fundamental shift from brick-and-mortar to the online platform and ANF has invested heavily in growing its Direct to Consumer (DTC) segment to adapt to this change. The company’s strategy is yielding results, as evidenced by the fact that digital sales exceeded $1 billion in 2018 – roughly 35% of total sales volume.
• This trend continued in Q1 with digital sales increasing to 30% of revenues, compared to 27% a year ago – driven by strong performance across the Hollister and Abercrombie brands. Moreover, the company’s direct involvement with the consumer is evident from the fact that the company’s ‘Pickup in Store’ program (that allows customers to place an order online and then pick up the merchandise in store) witnessed double-digit growth in Q1.
• We expect the DTC segment to be the key driver of the company’s top line growth in the coming years.

Hollister Still Holds The Key For Abercrombie’s Growth

• The Hollister brand has been the silver lining for Abercrombie & Fitch in recent years, with consistent growth across genders and channels. The brand posted an improvement of 2% in its comps for Q1 – marking its tenth consecutive quarter of growth in the metric thanks to strong sales in bottoms, activewear, swimwear, and intimates.
• Hollister achieved record first-quarter sales in pants and outerwear, and continued to attract new customers to its growing swimwear and intimates categories. Although, the brand didn’t perform up to the expectations in Q1, Hollister holds the key for Abercrombie’s growth in the near future

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Store Optimization Program

• ANF has been remodeling, resizing and relocating its brick and mortar stores over recent years. ANF’s store count has gone down from a peak of 1100 in 2010 to 861 in 2018, as the company remains focused on transitioning its retail presence into smaller, more omni-channel spaces in the best locations that can cater to both local customers as well as tourists. In line with this strategy, Abercrombie announced its decision to close 3 flagship stores in 2019, taking its total recent flagship closure count to 5. This represents a reduction of over 140,000 square feet of real estate that was operating well below the company’s average productivity.
• Moreover, the company plans to shutter another 40 stores in 2019 and approximately 50% of U.S. stores are up for renewal in 2019, giving the company the flexibility to close or remodel its existing stores. Closing unprofitable stores has helped the company to increase its revenue per square foot – thereby increasing its profitability.

International Business Has A Difficult Start To The Year

• Abercrombie’s international comps were negative 4% in Q1, with year-over-year sales declining by 6% to $264 million. This decline can be primarily attributed to the company’s soft performance in Asia where the company failed to introduce new offerings as some of its products faced acceptance issues in the region. However, the international business holds strong growth potential for Abercrombie as the company is still under penetrated in key markets across Europe and in China.

Future Outlook

• For the second quarter of fiscal 2019, Abercrombie expects net sales to be flat to up 2% while comparable sales are expected to be approximately flat. Gross profit margin is expected to be down approximately 100 basis points while operating expenses are projected to increase by 10% – primarily because of the one-time cost detailed above.
• Based on our full-year forecast, Abercrombie & Fitch’s adjusted EPS for full-year 2019 is likely to be around $1.46. Using this figure with our estimated forward P/E ratio of 18.8x, this works out to a price estimate of $27 for the company’s shares, which is about 55 % ahead of the current market price.

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