A Tough Comparison May Result In A Tough Third Quarter For Abercrombie & Fitch

Abercrombie & Fitch (NYSE:ANF) is slated to post its third quarter earnings on November 29, wherein a slight drop in sales (-0.6%) and a 33% fall in earnings per share is expected, with the metrics reaching $854.1 million and $0.20, respectively. For the third quarter, ANF believes net sales to be flat versus last year as a result of a tough comparison, and for the full year, the company continues to anticipate comp sales and net sales to be up in the range of 2% to 4%, despite a reduction in anticipated foreign currency benefits. The apparel retailer continues to focus on optimizing its global store network, enhancing its omnichannel capabilities, and growing its loyalty program. These efforts will go a long way in helping the company achieve its 2020 target of a low single-digit sales CAGR, modest gross margin expansion, and doubling of its 2017 adjusted EBIT margins.

We have a $24 price estimate for Abercrombie & Fitch, which is higher than the current market price. The charts have been made using our new, interactive platform. You can click here for our interactive dashboard on Estimating Abercrombie & Fitch’s Performance In Q3 2018 And Its Fair Price to modify the driver assumptions to gauge their impact on ANF’s revenue, earnings, or price per share metrics.

Factors That May Impact Future Performance

1. Potential of Gilly Hicks: Victoria’s Secret’s loss seems to be A&F’s gain. The former discontinued its swimwear line, and has suffered from a comps decline ever since. Abercrombie, on the other hand, witnessed aggressive growth in its Swim and Intimates line, with Gilly Hicks continuing to attract new customers to the Hollister brand. The Gilly Hicks brand was relaunched globally at the beginning of 2017, and seems poised for success in the future. Even for American Eagle, its lingerie and activewear brand, Aerie, has been its best performing segment for a while now, demonstrating the tremendous growth in this field.

2. Store Closures: Since 2010, over 400 stores have been closed, representing more than one-third of the company’s store count. Further, a significant number have been remodeled or downsized. In 2017, ANF closed 39 stores in the U.S. through natural lease expirations. For 2018, 60 more closures are intended, in addition to converting roughly 50 Hollister stores and 13 A&F stores into the new prototype format. Moreover, with about 60% of the U.S. leases expiring by the end of FY 2019, the company has significant flexibility to find the right store count balance, and drive efficiency by remodeling or resizing the stores, renegotiating leases, or shuttering some. The company is also shifting from large-format and its flagship stores to smaller, mall-based stores. The company noted that over the past two years, the total square footage was down 7%, and ANF saw a mid-single-digit improvement in overall real estate productivity. In theory, the company’s comparable sales should show an improvement when the unprofitable stores are closed down, particularly with a greater focus placed on the online segment. Besides, the revenue per square foot should increase with stores being downsized.

3. Strong Digital Sales: A fundamental shift from brick-and-mortar to the online platform is evident, and retail companies have to embrace this trend in order to remain relevant. In this regard, ANF has ensured local and regional fulfillment capabilities across the U.S. and around the globe, as well as supporting 20 websites and 4 apps in 11 local languages. ANF has made a considerable investment of roughly $400 million since 2010, to ensure the growth of its DTC (Direct To Consumer) segment, and has been rewarded as a result. DTC is now its largest storefront, with a growth of 16% in Q2, and constitutes 26% of the company’s sales volume. Moreover, mobile plays a huge part in the digital growth, representing 70% of the total DTC traffic. To better serve the customer’s needs, ANF has been evolving its omnichannel capabilities and has introduced Venmo as a payment option. Abercrombie’s digital store-centric functionalities such as purchase online, pick up in store, have been driving traffic to stores, and as a result, spurring the purchases and productivity within the store. The company has also introduced reserve-in-store that enables customers to try before buying, order-in-store, which displays all of the inventory to customers shopping in the stores, and ship-from-store, which enables ANF to maximize its inventory. These efforts should ensure a sustained growth in digital sales.

4. Scope For International Growth: While the company has been focusing on right-sizing its store footprint in North America, it is dependent on the international markets for growth through expansion. In Europe, the company sees a $1 billion opportunity across all channels. At present, the company has a modest 117 stores in the region. Consequently, its focus in the region is on increasing penetration, shifting to smaller, more productive stores, and building a more local customer base. The company’s partnership with wholesalers, like ASOS, NEXT, and Zalando, should ensure online sales growth. In China, the company estimates a $500 million opportunity. The company currently has only 28 stores in the country, and is focusing on growing its digital business, through its partnership with Alibaba, as well as its store count, to address this opportunity.

5. Hollister Growth Remains Strong: The brand posted 4% improvement in its comps in Q2, its seventh consecutive quarter of growth in the metric. An increase was seen across genders and channels, with the highest second-quarter sales volume in the brand’s history, driven by the record Q2 of sales in jeans, swim, and intimate. The brand has also instituted a number of marketing campaigns and programs, such as the Carpe Denim campaign, High School Ambassador program, and the Age Collective, to remain close to its target market, and understand the changing trends and preferences.

6. Campus Based Stores: ANF has opened two college campus stores – in The Ohio State University and the University of Southern California – in order to be closer to its target demographic of 18 to 25 year olds. These stores are half the size of an average Abercrombie store, equipped with the full omnichannel capabilities, which includes the possibility to purchase items online and pick up in store, order in store, or ship from the store. On campus events may help to drive traffic to these stores, and the smaller format of the stores will provide insights into driving productivity through compact stores.

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