Abercrombie & Fitch Comes Out on Topless
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Abercrombie & Fitch (NYSE: ANF) has been doing some soul searching after taking a beating in the markets in the wake of the Great Recession. A&F held fast on pricing even as the economy spiraled downward, resisting cutting prices or offering promotions for fear of diluting brand equity in anticipation of a rebound and a return to normalcy. That of course never happened. This was a strategic blunder that the company is just now recovering from.
While A&F waited for the good old days to come back, the rest of the world was already moving on.
Staying the Course
This is the new normal, where the average family net worth is down 40% and Groupon has taught the world that they no longer have to pay full price for most anything. In a survey of shoppers by America's Research Group, 60% of men and 80% of women said they will no longer shop in high-end clothing stores. With 50 million Americans on food stamps, how many of them can afford to buy clothes at Wal-Mart, no less Abercrombie & Fitch.
While topless male models fiddled in the aisles, Rome was burning. A&F was doubling down on a brand image that seemed as outdated and irrelevant as an episode of “Flip This House.” As a result Abercrombie's Q2 profits plunged in 2009 134% year over year. Meanwhile during the same period, rival Aéropostale's (NYSE: ARO) profits shot up 83%; a result of price cutting, promotions and a good old fashioned dedication to moving product.
In Q2 2008 Abercrombie reported profits of $77.8 million. A year later that had dropped off 30% across its Abercrombie (567 stores), Hollister (520 stores) and Ruehl brands. Ruehl has since been shut down.
Feeling the Heat
By Q3 2009 Abercrombie had suffered enough and capitulated to price reductions, slashing prices up to 90% to clear inventory and rescue plunging revenues. The company adopted a strategic price promotion strategy to achieve higher revenues while at the same time managing to maintain the brand’s premium appeal.
Sales from its 28 overseas stores (out of a total of 1,096) helped prop up Abercrombie, growing at a brisk 86% and accounting for more than 15% of total revenue in Q4 2009. According to A&F CEO Mike Jefferies, “international expansion is firmly in our grasp and as I’ve said before it is the future of our brands.”
To that end, the company has expanded international operations in Europe and Asia where there was still an appetite for premium brands. Things began to look up in 2011 as results showed profits leaping 95% in Q4 2010 and same store sales growing by 7% in the US.
The A&F brand still holds sway with foreign shoppers, as evidenced by the success of its three international flagship stores, which generate annual revenue of $200 million, as well as its Fifth Avenue store in New York City, a favorite of tourists, which generates over $100 million in revenue annually and remains A&F’s most lucrative single location. In December 2011 Abercrombie opened its first store in Singapore, where its scantily clad models and outdoor ads have caused a stir among the more conservative Asian population. A&F also debuted in China in 2011, opening a Hollister store in Hong Kong, a move aimed at establishing a foothold toward expansion into mainland China. The company also has two successful stores in Japan.
Stripping Things Bare
Abercrombie projects sales of $7.5 billion in 2015, a CAGR of 15.7%, on the strength of continuing international penetration. That target assumes a 50-50 split from its US and overseas stores, thanks to reduced US locations and exploding international sales, as well as continued growth in its direct-to-consumer channels, which rose 40% in Q1 2012. A&F made $2.19 in 2011 and projects to make $3.50 to $3.75 per share in 2012, nearly all of which is due to happen in the last three quarters of 2012 as Q1 this year, for while sales growth was strong -- up 10% -- so was inventory, up 44%. The term channel stuffing comes to mind.
The turnaround story for A&F got a quarter or two ahead of itself, which this latest earnings report crystallized. In a fear-driven market, punishment will be severe. With the stock trading below the $33 price band, near-term support might develop in the $29 range on the hope that the next earnings report justifies a growth multiple on a stock whose margins are being destroyed in restructuring. If $28 does not hold then $20 looks like the likely 2012 low.
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