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Investment Overview for Abercrombie & Fitch Co. (NYSE:ANF)
- Hollister Stores Revenue per Square Foot: Hollister stores revenue per square foot increased by a massive 21% in 2011 to reach $450 and further rose to $475 in 2012. This increase was primarily due to strong performance of Hollister in international markets. We expect the trend to carry forward, and forecast revenue per square to increase and reach $546 by the end of the Trefis forecast period.
However, the current weak macro-economic conditions in Europe threaten to put a break on Hollister's international growth. If weak macro-economic situation in Europe persists and revenue per square foot just reaches $490 by the end of the Trefis forecast period, there could be 5%-10% downside to our price estimate. Conversely, if the European economy recovers fast, the brand expands in lucrative markets such as Russia and Germany, and revenue per square foot increases to $650 by the end of the Trefis forecast period, there could be 5% upside to our price estimate.
- Hollister Stores EBITDA Margin: Hollister Stores' EBITDA Margins declined drastically in 2011 due to a sudden increase in cotton costs. In 2012, despite lower cotton prices, the decrease continued as the company ushered large discounts due to inventory hangover. However, the company has started addressing this issue, which should reflect as better margins in the future. We expect the figure to slightly increase and stabilize at 18.4% by the end of the Trefis forecast period.
However, if the apparel market continues to be exceptionally promotional and margin's plummet further to 16.5% by the end of the Trefis forecast period, there could be 5% downside our Trefis price estimate. Conversely, if the macro-economic conditions improve, promotional environment ceases to continue and margins increase to 20%, there could be 5% upside to our price estimate.
Abercrombie & Fitch is a specialty retailer that operates stores and websites selling casual sportswear apparel, including knitted and woven shirts, graphic t-shirts, fleece, jeans and woven pants, shorts, sweaters, outerwear, personal care products, and accessories for men, women and kids under the Abercrombie & Fitch, Abercrombie kids and Hollister brands. In addition, the company operates stores and a website offering bras, underwear, personal care products, sleepwear and at home products for women under the Gilly Hicks brand.
Hollister stores revenue per square foot and number of Hollister stores
Solid international business was the primary growth driver for Hollister stores revenue per square foot in 2011 & 2012. Additionally, Abercrombie doubled its intentional Hollister stores count in 2011 by opening 39 new stores. It further added 40 such stores in 2012 and has plans to another 20 this year.
Rapidly growing direct to consumer business
Internet revenues increased from $310 million in 2008 to $701 million in 2012. The aggressive growth is expected to continue going ahead. With the anticipated growth in online apparel sales in the U.S., Abercrombie's plans to become a $1 billion e-commerce brand and the development of e-commerce channels remain a high priority for the company.
Consolidation of Abercrombie & Fitch stores in the U.S.
Due to ANF's over expansion in the U.S., fewer promotions and the economic downturn of 2008-2009, its comparable store sales fell by 13% and 23% in 2008-2009. However, with the consolidation of under-performing stores and the improvement in the economy, Abercrombie & Fitch stores have started to recover. The retailer reduced the total number of ANF stores from 358 in 2008 to 290 in 2012. At the same time, the revenue per square feet increased from $440 to $518.
Controlled expansion in Europe due to weak economic environment and threat of self-cannibalization
Abercrombie's growth in Europe has been under pressure primarily due to the weak economic environment and self-cannibalization. For instance in Q3 fiscal 2012, international comparable store sales declined by 18%. Self-cannibalization has become a concern due to the retailer's over expansion in tourist locations and local catchments. The company has announced that it will slow down the expansion in the European markets. To expand in the region, under-penetrated markets will be targeted to negate the impact of cannibalization. Although the weak economic environment in Europe poses a near term threat, the region has good market potential over the long run.
Proper inventory control
During 2011, Abercrombie & Fitch has had difficulty in managing its inventory. This resulted in excessive promotions, which led to decline in the average price per unit. This not only impacted the comparable store sales, but also weighed on the retailer’s margins. To address this issue, Abercrombie & Fitch is increasing its inventory at a much slower pace than the sales growth. The retailer had a very low inventory turnover in 2011 (ratio of sales to inventory), indicating that the increase in sales was lower than the increase in inventory. Moreover, the retailer started sourcing the goods from within the U.S. and low-cost destinations of Central America, thus reducing the lead time.
However, Abercrombie & Fitch went too far with its inventory control. The company’s inventory levels dipped too low in the first quarter of fiscal 2013, leading to a sharp decline in its comparable store sales. According to Abercrombie’s management, about 10% of the 17% decline in comparable store sales was due to inventory issues. Abercrombie has become a good example of how important it is for any retailer to maintain optimum inventory levels.
Better customer engagement
Abercrombie recently initiated its first global market research study to better understand customers and competitors in different markets such as North America, Europe and Asia. Also, the retailer launched a loyalty club program for its ANF brand last year that offers discounts, gift certificates and other rewards. It provides free shipping for online orders and access to exclusive music videos and photo galleries on its website. n the initial stages of this program, more than 750,000 customers signed up and started buying more than the regular customers. Towards the end of the fourth quarter, this figure increased to more than 1.5 million. This is in addition to 3.5 million existing customer contacts. Such programs will help Abercrombie in keeping the customers interested in its brands.
Trefis Forecast Rationale for Internet & Catalog Orders EBITDA Margin
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) are profits after factoring in typical expenses such as cost of goods and services sold, SG&A expenses and R&D expenses. EBITDA Margin represents divisional EBITDA as a percentage of divisional revenues. We adjust EBITDA figures to exclude non-recurring charges and non-cash charges such as stock-based compensation expense, asset impairment charges, asset write-down charges, legal charges and auction rate impairment (ARS) charges.
The EBITDA Margin for the Internet & Catalog Orders division increased from around 50% in 2008 to around 48.7% in 2009 driven by growing popularity of e-commerce and the company's online marketing initiatives.
The figure declined to 48.5% in 2010, due to an increase in direct-to-consumer expenses. Margins declined to 47.7% in 2011, primarily as a result of an increase in cotton prices which pushed the average unit cost (AUC) up. In 2012, with lower cotton prices, margins improved to 50.7%.
Going forward we expect the margins to remain at the constant level of 50.7%. Though an improvement in cotton prices should increase the margins, a simultaneous increase in operational expenses due to the expansion of e-commerce channel will neutralize that.
Trefis considered the following factors for its forecast:
- A drastic change in cotton prices is less likely
- From $0.84 per pound in July 2010, cotton prices rose to $2.30 per pound in March 2011. The major factor behind this price increase was the drought in Hubei province of China, a major cotton producing area. Government restrictions on exporting cotton out of India and a devastating flood in Pakistan further contributed to the supply shortage.
- As cotton is one of the key raw materials for apparel retailers, a sudden spike in cotton prices resulted in an increase in manufacturing costs. However, cotton prices declined to $0.83 per pound by the end of 2012 as China recovered from the drought and India eased its regulation on cotton export.
- Cotton prices have declined thereafter, reaching $1.01 per pound by the end of January 2012.
- With China steadily building up its cotton reserves, we do not expect cotton prices to go up. Currently the country holds a record cotton inventory of 10 million tons, which has brought the U.S. cotton prices per pound down from 88 cents in 2012 to 71 cents in 2013.
- With ample cotton reserves and lower prices, retailers such as Abercrombie & Fitch should be able to reduce their manufacturing costs and sustain margins.
- Inventory control should allow limited promotional activities
- Abercrombie is looking to increase its inventory at a much slower pace than its sales growth. Low carryover of fall inventory in Q4 fiscal 2012, and 35% lower inventory (as compared Q4 fiscal 2011) at the end of the same quarter were indicative of this effort.
- This helped Abercrombie in reducing the number of markdowns and improve its margins.
- The retailer is also increasing its vendor collaborations to utilize its supply chain expertise during product development cycle, which will help in timely delivery of merchandise. Ultimately, this should lead to an increase in full priced sales resulting in better AUR.
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- With the further expansion of its online business, the division's operating costs may increase
- The company has made plans for expanding its online business to Canada and Europe. As a result, the company may have to deal with rising operating costs.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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