Abercrombie Slump Overdone, Despite Margin Concerns
November is turning out to be a rough month for Abercrombie & Fitch (NYSE:ANF) and its investors. The teen apparel retailer’s stock was thumped by over 15% Wednesday after its disappointing Q3 earnings report. [1] While a decline in gross margins by 3.6% was primarily responsible for the slump, concerns over Abercrombie’s slowing international business also contributed to the fall. Despite this, the company’s management confidently dismissed the concerns on its slowing international business as hype. Though we believe the decline in gross margins is a source of concern, the crash in ANF’s stock was a bit overdone in our view. Abercrombie & Fitch competes with other specialty retailers such as Aeropostale (NYSE:ARO), American Eagle Outfitters (NYSE:AEO) and Gap Inc. (NYSE:GPS) in the teen apparel space.
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Check out our complete analysis of Abercrombie & Fitch
Gross margins still a concern
Decline in gross margins by over 3.5 points was the primary reason behind yesterday’s stock slump. Although top line growth of 21% was encouraging, the decline in gross margins mitigated these gains. While Abercrombie suggested the decline in margins a consequence of decreasing Average Unit Retail (AUR) due to promotions and increasing Average Unit Cost (AUC) due to rising production costs, this pressure on margins was still higher than anticipated considering the tailwinds garnered by increase of 41% in company’s internet revenues.
We believe that declining gross margins will continue to be a source of concern for the company. Considering the fact that in the last quarter Abercrombie’s margins declined by just 1.5 points, a 3.6% margin decline highlights the extent to which Abercrombie is being forced to cut prices and run promotions to boost sales growth. While Abercrombie is banking on hiking prices and lower product costs in the future, we remain cautious until we see this evidence.
Given the current macro-economic weakness, price competitiveness is gaining over brand awareness we think Abercrombie will face pressure from those like Aeropostale and Gap.
Ailing international business: Truth or Hype and Our Take
The declining international business particularly in Europe also contributed heavily in the ANF’s decline during November.Though we believe that Abercrombie’s European growth has certainly slowed compared to the last two to three quarters, we consider the recent slump as a little exaggerated.
While Hollister continues its run in Europe, it is the slowdown in the company’s flagship stores which is behind the market’s concerns. We believe that with the robust growth opportunities still available in Europe and Abercrombie’s entry into huge new markets such as China, presents good international growth opportunities for ANF. Additionally, the company will also benefit from the roll out of its international e-commerce plans in the near to medium term.
Our current price estimate for Abercrombie & Fitch’s stock stands at $64 which is roughly 30% above the current market price. We are in the process of revising our price estimate.
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Notes:- Abercrombie reports Q3 earnings, Source: Abercrombie & Fitch’s IR [↩]