How Important Are E-Commerce Sales to This Specialty Retailer's Stock?

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With the growing popularity of smartphones and tablets, Internet penetration is also rapidly increasing. According to the latest research published by Forrester, this year's U.S. online retail sales should represent a 12% increase versus 2012 levels. Further, by 2017, the total estimated size of the U.S. online market should reach $370 billion from $262 billion, which gives us a compounded annual growth rate of 9% from 2014 to 2017. 

It's worth noting that Abercrombie & Fitch’s (NYSE: ANF) direct-to-consumer business is predominantly comprised of the e-commerce channel. The direct-to-consumer business incurred significant losses during 2008 and 2009 as the macroeconomic environment was highly unfavorable and consumer spending was at an all time low.

Nevertheless, over the last two years Abercrombie & Fitch has experienced strong growth in the e-commerce channel, as total revenue from this market segment grew to $700 million last year. The company's direct-to-consumer business has experienced a year-over-year growth rate of 27% since 2007. Abercrombie’s ingress into mobile commerce and the launch of its e-commerce website in Europe were other key contributing factors to the top-line growth during 2012.

Global revenue from the direct-to-consumer business grew from $410 million in 2010 to $700 million by 2012. Given that the online apparel market is estimated to grow exponentially in the U.S. during the next few years, Abercrombie & Fitch's online revenue is expected to surpass $1.5 billion.

This makes Abercrombie & Fitch's e-commerce platform a significant contributor to overall revenue, and a pertinent revenue stream that will underpin its future growth.

Estimating growth in the online apparel market

Abiding by Forrester's aforementioned U.S. market growth projections, and assuming a slight decline of 2% to 3% in the growth rate after 2017, the total market size will still increase to $420 billion (assuming a growth rate of 6.5% from 2017) by 2019.

The size of the U.S. online retail market stood at $176 billion at the end of 2010. Therefore, it's fair to say that the U.S. online retail market should report a CAGR of 10% between 2010 and 2019.

Traditionally, the online retail apparel market has reported a faster growth rate relative to the overall online retail market. It's worth noting that from 2004 to 2009 total U.S. online retail sales experienced a growth rate of 16%. In contrast, online apparel sales grew by 19%.

Considering that the online apparel market size was $2.9 billion in 2009, and assuming this channel continues to grow at a faster rate than the overall online retail market (assuming a 12% growth rate), the size of online apparel market should reach $9 billion by the end of 2019.

Abercrombie & Fitch claimed an online apparel market share of 15% during 2011. Let's assume growth in the online retail sales segment slows down slightly and Abercrombie's market share only manages to reach 17% by 2019. Then, the company's total U.S. online sales should stand at $1.5 billion by 2019, as per my estimates.

Efforts to bolster "m-commerce" sales 

During 2010, Abercrombie & Fitch entered the mobile-commerce, or m-commerce, channel, facilitated by Digby’s platform, which made the retailer's website available on Internet-enabled mobile phones. This allowed its customers to purchase from its website using only their mobile devices. In addition, it also launched an all new iPad application to promote its e-commerce site.

Mobile commerce sales are now an integral part of the U.S. e-commerce business. Sales from the mobile commerce unit accounted for roughly 3% of the company's total U.S. e-commerce sales in 2012.

Going forward, the contribution from mobile commerce is estimated to reach 9%; thus Abercrombie & Fitch’s efforts to develop a stronger mobile-commerce channel will prove crucial to its earnings.

Increasing competition

The growth in online retailing and the efforts made by Abercrombie & Fitch should bolster the company's sales in the future. Nevertheless, increasing competition from retailers such as Urban Outfitters (NASDAQ: URBN) and American Eagle Outfitters (NYSE: AEO) will not make life any easier.

Urban Outfitters generates a large percentage of its revenue through Internet and catalog orders. Presently, e-commerce sales account for 23% of total revenue, which makes it the second-largest revenue stream after its retail stores.

During fiscal 2012, the company operated an EBITDA margin of approximately 24%. In contrast, Internet and catalog orders operate on an EBITDA margin of 36%. This largely underpins the importance of e-commerce sales for apparel retailers.

Urban Outfitters has a market cap of $5.8 billion, and based on its recent share price the stock is trading at around 91% of its 52-week high. According to the valuation offered by Trefis, the FCF-EBITDA is expected at around 46% this year.

American Eagle Outfitters generates 80% of its revenue through self-owned stores. Internet and catalog orders contribute 13% to the top line. During fiscal 2012, the company operated on an EBITDA margin of 26%. In contrast, Internet and catalog orders operated on an EBITDA margin of 40%. According to the valuation offered by Trefis, the FCF-EBITDA is expected at around 66% this year.

American Eagle Outfitters has a market cap of $3.7 billion, and based on the recent share price the stock trades at around 81% of its 52-week high. Internet and catalog orders operate on relatively much higher margins, and going forward I expect all U.S. apparel retailers to make special efforts to bolster the e-commerce channel.

Importance of online sales

At present, the global revenue from the online channel for Abercrombie & Fitch stands at $700 million. My current forecast suggests Abercrombie & Fitch’s online sales in the U.S. will surpass $1.5 billion by 2019.

However, it's worth noting that the company also possesses an e-commerce presence in Europe. In a scenario where macro-economic conditions improve and international growth accelerates, then total online sales could exceed $2 billion by the end of 2019.

With the right product mix and marketing strategy for the e-commerce platform, Abercrombie & Fitch can attain a strong upside to its share price. The operating margins in the e-commerce division are relatively high, and going forward online sales of all apparel retailers will define success or failure for the season.

Ashit Gulati has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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