Abercrombie & Fitch; The Fickle World of Fashion

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Try as I might, there is no way that I can possibly keep up with the world of fashion --- although it is not my job. However, it is the job of fashion brand Abercrombie & Fitch Co. (NYSE: ANF) and it would appear that they don't really know how to do it either.

I'm talking here about inventory levels, in particular, abnormally high or low inventory levels that force the company to discount heavily to try and shift unwanted stock. This was an issue Abercrombie had back in early 2012 as the company's clientele put off purchases due to weather, fashion trend and cost issues.

<img alt="" src="http://g.fool.com/editorial/images/51076/1_large.png" />

As the chart shows in the Fourth Quarter (Q4) of 2011 the company had abnormally high level of inventory, selling this off at discounted prices pushed down the company's Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) margin, eventually pushing the company into a loss.

The chart also shows falling levels of inventory at the beginning of this year as the company has focused on inventory control to keep margins and profits high. Matching inventory levels to sales = stronger profits.

It's not just Abercrombie

It is not just Abercrombie that has had a problem with its level of inventory and changing consumer habits. Abercrombie's close competitor's Guess? Inc. (NYSE: GES) has also had to discount heavily to sell down high levels of inventory.

<img alt="" src="http://g.fool.com/editorial/images/51076/2_large.png" />

Higher than average levels of inventory at Guess? during Q2 2012 through to Q4 2012 resulted in discounting and lower EBITDA margins for the company.

However, like Abercrombie it would appear that Guess? has managed to control its inventory and improve margins during the first quarter of this year.

Meanwhile, Urban Outfitters (NASDAQ: URBN) has managed to maintain its margins even with high levels of inventory during the last quarter of 2012 and first quarter of 2013.

<img alt="" src="http://g.fool.com/editorial/images/51076/3_large.png" />

However, the company was forced to discount it's higher than average level of inventory heavily back in Q4 2011, which resulted in the company's EBITDA margin falling 400 bps between Q4 2011 and Q1 2012.

So, what about future trends?

Although Abercrombie may have got last year's inventory issues under control, the company has been subject to a lot of negative press in these last few months. The company has been the subject of boycotts and internet campaigns trying to get customers to walk away after an interview with CEO Mike Jeffries, given back in 2006 re-surfaced.

I won't repeat the whole interview here, but the in a quick summary, Jeffries suggests that his brand is tailored to only attractive people and he does not what overweight customers - (of course a comment like this would cause trouble but why have people only started paying attention now, 7 years after the interview was given?)

The impact of this negative publicity is yet unknown, although slower sales for the company could once again lead to higher levels of inventory and discounting throughout the rest of the year, which would push down margins and profits --- just after the company has got back up on its feet after 2012.

However, the company does have two factors that could work in its favour. Firstly, the fashion world and retail customers in general have a short memory and a season of discounts on quality clothing will bring them back.

Secondly, no publicity is bad publicity.

Conclusion

Inventory levels have been a problem for Abercrombie in the past and the company could be faced with these problems again over the next few months, as consumers move away from the brand after this quarter's negative PR. 

Based on that speculation, I believe that for the time being, until the effect of this negative PR is known, investors should stay away from the company. If Abercrombie finished this quarter with high levels of inventory, significant discounting and falling profits could follow in Q3.


Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool recommends Guess?. The Motley Fool owns shares of Guess?. 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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