Specialty apparel retailer Abercrombie & Fitch (NYSE:ANF) is working hard to ensure the turnaround of its business in 2014. Soon after the retailer made some significant changes to its corporate governance structure, it hired tech firm First Insight Inc to work on its core issues.  As this news came out, the company’s shares increased by about 5%. Amid intense competition from fast-fashion retailers, Abercrombie has been struggling for growth due to poor customer response to its products. First Insight Inc specializes in providing price and product recommendations to its clients by closely monitoring consumer behavior over the Internet.  Through this deal, the company can better understand its shoppers’ tastes and needs before investing in a new product line. This way, it will be able to provide only the most relevant merchandise to its customers.
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Although the deal in itself might not be a significant development, we believe that Abercrombie has a taken a step that was desperately needed. Investors were unhappy with the company’s leadership, its brand image was deteriorating, and its sales were falling. Sooner or later, Abercrombie had to do something about its product portfolio.
Abercrombie, which was once one of the most popular apparel brands is the U.S., still has a long way to go to rejuvenate its brand appeal. However, this is a good start. If the change in the design system helps improve its product offerings, we can see an upside of about 10% to its price.
Our price estimate for Abercrombie & Fitch stands at $37.62, implying a premium of about 10% to the market price.
What’s Behind Abercrombie’s Problems?
One of the biggest problems with launching a new fashion collection is that its success is largely based on predictions. In case these products do not find good customer acceptance, sales go down and inventory piles up. To make way for the next season’s inventory, a retailer has to usher heavy markdowns, which weighs on its comparable store sales and margins. This has been the case with Abercrombie for more than a year now. Moreover, the retailer’s improper inventory management and controversy around its brand image have added to its miseries. As a result, Abercrombie’s comparable store sales have gone down considerably over the last three to four quarters.
In addition, the U.S. retail market has been relatively bleak over the last one year on account of increased taxes, slow job growth, higher healthcare costs, etc. Also, consumers diverted a part of their spending to long lasting products such as cars and houses to take advantage of low mortagage rates. Subsequently, they spent less on apparel and accessories. Being a relatively expensive brand, Abercrombie was at the receiving end of this trend. Consumers shifted to other low-cost fast-fashion brands such as Forever 21, Zara, H&M, and Gap (NYSE:GPS), and bought less at Abercrombie.
How Will First Insight Inc Help Abercrombie?
Abercrombie hired First Insight Inc. to make better informed decisions regarding its products and prices. As a part of the deal, First Insight Inc will leverage online social engagement tools to study consumer preferences, and provide predictive analysis to the company.  Subsequently, the apparel retailer will have a better knowledge of products and prices that are most likely to be welcomed by fashion and price sensitive teenagers. Abercrombie will start testing new products (in terms of design and prices ) in its stores on weekly basis. First Insight Inc will also incorporate customer feedback before giving an investment recommendation to Abercrombie.
With the launch of new products at prices that are attractive to a teenage buyer, Abercrombie’s brand perception can change gradually. This can facilitate more full priced sales, which will have a positive impact on the company’s comparable sales and margins. Furthermore, it will help Abercrombie improve its inventory management. Although the recovery process will be slow, we believe that the company has taken a step in the right direction. Abercrombie’s GVP Gillian Galner said that ” First Insight will be a critical element in the transformative changes to our business”. 
Will There Be Any Impact?
Abecrombie’s namesake brand’s revenue per square feet (a measure of comparable store sales) increased marginally to $518 in 2012 and went down considerably in 2013 (we’ll get the figures once the company reports its Q4 results). From this point, we expect the figure to recover slowly over the years and reach $540 by the end of our forecast period. The retailer’s Hollister brand has followed a similar trend as well. Its revenue per square feet (RPSF) went up from $452 in 2011 to $475 in 2012 and we project it to plummet to $430 in 2013. According to our current forecast, the figure will improve gradually and reach its 2012 levels over the course of next five-six years.
With this agreement, Abercrombie has made a big change to its merchandise design system. We expect this move to help the company revamp its product offerings. If it manages to do so, its revenue per square feet can go further up driven by more full priced sales and customers. Assuming that Abercrombie & Fitch’s RPSF increases to $580 instead of $540, Hollister’s RPSF goes up to $520 instead of $480, and the company’s direct-to-consumer revenues also improve, there can be about 10% upside to our price estimate. However, it still remains to be seen how valuable First Insight’s predictive analytics turn out.Notes:
- First Insight Announces Partnership with Abercrombie & Fitch, Business Wire, Feb 5 2014 [↩] [↩]
- First Insight partners retailer Abercrombie & Fitch, Fibre2fashion, Feb 6 2014 [↩] [↩]