What Abercrombie’s Q3 Business Update Means?

Abercrombie & Fitch‘s (NYSE:ANF) shares plunged by close to 15% last week after it provided its third quarter business update. The company reported that its net sales in the third quarter decreased by a staggering 12%, with 10% fall in comparable sales. It is worth noting that the company’s comparable sales declined significantly despite 8% rise in direct-to-consumer revenues. Decline in comparable sales was more intense in international markets as foot traffic in European stores fell significantly during the quarter. Overall, comparable sales fell 8% in the U.S. and 15% internationally. Abercrombie’s sales were going weak in August and sales trends worsened in the subsequent months, despite the marginal improvement in the U.S. macro-economic environment. Apart from weak traffic in Europe, poor demand for logo products also had a severe impact on the retailer’s sales. It ushered heavy markdowns to compensate for low traffic and weak demand, that weighed on its gross margins during the third quarter. Abercrombie stated in its update that it now expects its Q3 gross margins to erode moderately as compared to the same quarter last year. Along with updates on its sales growth, the company guided its non-GAAP net income per diluted share at $0.40-$0.42. ^[1]

Our price estimate for Abercrombie & Fitch stands at $39, which is about 35% above the current market price.

See our complete analysis for Abercrombie & Fitch

Amid Abercrombie’s disappointing Q3 update, we believe that there was a silver lining. With a slump in demand for the brand’s basic logo products, it has become somewhat clear that the company has efficiently identified its shortcomings. During its second quarter earnings call, the management had stated that they were looking to reduce Abercrombie’s logo portfolio to “almost nothing” over the course of next 12 months. ^[2] Although this was a risky bet, the retailer believed that its brand image needed an overhaul in the wake of deteriorating customer loyalty. However with this strategy, the company has created a difficult situation for itself, that can hamper buyer interest in the brand in the near term. While most buyers have shunned basic logo products lately, those who are actually buying such clothing would have seen fewer options at Abercrombie. As a result, they might have bought less or moved to other basic apparel retailers such as Aeropostale (NYSE:ARO) and American Eagle Outfitters (NYSE:AEO), which would have intensified the retailer’s store traffic slump. Nevertheless, Abercrombie’s CEO Mike Jeffries stated that the company will persevere with this strategy for long term benefits. He said during the business update that the company believes it is taking the right steps for future improvements such as aligning its merchandise offering with consumer preferences, reconnecting with buyers through store re-design and appealing marketing, closing underperforming U.S. stores, reducing expenses and investing in Asian expansion and direct-to-consumer business.

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1. Abercrombie & Fitch Provides Third Quarter Business Update, Abercrombie & Fitch, Nov 7 2014 [↩]
2. Abercrombie & Fitch’s Q2 fiscal 2014 earnings transcript, Aug 28 2014 [↩]