Specialty apparel retailer Abercrombie & Fitch (NYSE:ANF) has been struggling for some time now with inventory issues, an aggressive European expansion and the overall weakness in the U.S. apparel industry. The company’s troubles continue and will no doubt be reflected with its Q3 fiscal 2013 results on November 21. (Fiscal years end with January) In a recent business update, Abercrombie stated that its revenues and comparable store sales declined by 12% and 14% respectively in the third quarter.  So its duress continues.
These results are not surprising as Abercrombie has been struggling to hold onto its customers in a highly competitive retail environment. The company has been hurt by fast-fashion and low-cost chains such as H&M and Forever 21, which have been taking away market share from traditional apparel retailers. The apparel industry itself is going through a slump as U.S. buyers have been extremely reluctant to spend on discretionary products. Though Abercrombie’s Direct-to-Consumer channel continues to grow at a steady pace, it will not have any noticeable impact on the upcoming results.
Our price estimate for Abercrombie & Fitch stands at $40, implying a premium of about 15% to the market price. However, we will update our price estimate after the earnings announcement.
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Apparel Retail Industry Remains Sluggish
Slow job growth, increased taxes and a change in consumer preferences have severely hit the discretionary consumer spending in the U.S. The 2% payroll tax increase at the start of the year has left U.S. buyers with less to spend, and high unemployment has negatively impacted consumer confidence. Moreover with still low interest rates, some buyers have diverted their spending to cars and houses, while holding back on other products. This trend has particularly hit the apparel sector with a number of big players striving for positive comparable store sales growth. As a result, U.S. retailers have relied on deep discounts to drive store traffic, which has weighed heavily on their growth and profitability. According to the Commerce Department, retail sales in August (excluding the automotive sector) increased by just 0.1%. In September, several apparel retailers, such as Gap Inc (NYSE:GPS), Zumiez Inc, The Buckle Inc and American Apparel Inc, posted comparable store sales declines. Moreover, retailers registered only modest growth in October due to slow job growth, low consumer confidence and warmer than usual weather. This last factor impaired the demand for cool weather apparel.  When the market is weak, even a retailer’s small problems get magnified and hamper its growth. This has been the case with a number of U.S. retailers, including Aeropostale (NYSE:ARO), American Eagle Outfitters (NYSE:AEO) and Abercrombie & Fitch.
Fickle Customer Base Is Hurting Abercrombie
This year, teenage customers have shown low brand loyalty as they have been readily shifting to brands that provide relevant fashion at reasonable prices. Abercrombie is at the receiving end of this trend as it has been losing its customers to fast-fashion operators such as Zara, Forever 21 and H&M. Since these players offer their products at affordable prices, shoppers have preferred them over relatively expensive Abercrombie. Moreover, with more desirable merchandise, they have the ability to quickly turnaround the latest fashion trends. In contrast, Abercrombie has been unable to do so due to its inventory problems. Often, the retailer’s stores end up huge amount of unsold inventory that needs to be cleared before new products can be launched. Due to this, the retailer lags behind the prevailing fashion and ultimately loses its customers to fashion responsive brands. This still remains an issue for Abercrombie as it is offering heavy discounts to attain a clean inventory position for the holiday season. 
Direct-To-Consumer Growth Won’t Help
Abercrombie’s Direct-to-Consumer business (mainly e-commerce) has grown at an average annual rate of around 35% for the last three years. Although revenues declined by 10% in the first quarter due to inventory shortage, direct sales grew by 21% in Q2 fiscal 2013, despite overall weakness. The company realized this growth on the back of its strong e-commerce and m-commerce channel, and a surge in the U.S. online apparel industry at large. In its recent business update, the company stated its Direct-to-Consumer revenues increased by 11% during the third quarter.  Although this growth looks promising from long term perspective, it was not able to lift Abercrombie’s results. Currently, this channel accounts for only 16% of the retailer’s net sales and thus, is not strong enough to drive its growth. Though Abercrombie is looking to increase the revenue contribution of this channel by boosting mobile investments and omni channel retailing, it needs to focus on its products in order to regain its loyal customer base.Notes:
- Abercrombie & Fitch Provides Business Update Announces Restructuring Plan For Gilly Hicks Brand Amends Credit Agreement, Abercrombie & Fitch, Nov 5 2013 [↩] [↩]
- Warm october could hinder fall retail sales, Yahoo Finance, Oct 8 2013 [↩]
- Abercrombie promises more styles, sizes for women, Reuters, Nov 6 2013 [↩]