Is Abercrombie & Fitch Fighting A Losing Battle To Keep Expenses In Check?

Abercrombie & Fitch (NYSE: ANF) has seen steady growth in revenues over recent years, but these revenues have been accompanied by a near-identical increase in expenses. Notably, expenses for the apparel company have averaged 99% of revenues for the last five years – resulting in razor-thin margins and a net income figure of less than $75 million for each of the last five fiscal years despite revenues averaging $3.5 billion.

While the apparel business is extremely competitive, A&F’s average net income margin figure of just 1% over recent years indicates that the company is struggling to keep expenses in check. Although things improved sequentially in 2018, one-time charges of ~$65 million (which includes an asset impairment charge and flagship store exit charges) for the current year are likely to result in the company barely staying out of the red in 2019. To better understand the factors weighing against the company’s profits, Trefis details Abercrombie & Fitch’s Expenses in an interactive dashboard, parts of which are summarized below.

• Abercrombie’s Total expenses as a % of revenue increased from 98.0% in 2015 to almost 100% in 2016 primarily because store & distribution expenses remained elevated even as revenues nudged lower. This metric declined to 97.9% by 2018 resulting from the lower cost of sales (as % of revenue).
• Moreover, one-time charges incurred over FY 2016-18, resulting from under-performance and expected store closures, have further aided the growth in the total expenses.
• Total expenses as % of revenue are expected to increase from 97.9% in 2018 to 98.7% in 2019 mainly due to one-time charges which includes flagship store exit charges of $45 million incurred during the second quarter of 2019.

Breakdown of Abercrombie & Fitch’s Expenses

Cost of Sales

• Cost of sales primarily consists of the cost incurred to ready inventory for sale, including product costs, freight, and import costs, as well as provisions for reserves. Cost of sales as % of revenue has been constant around 40% over the last few years.
• This metric rose to 40.3% in FY 2017 primarily due to lower average unit retail sales, including the adverse effects from changes in foreign currency exchange rates.
• We expect the cost of sales to increase to 40.8% in FY 2019 reflecting a combined adverse impact from changes in foreign exchange rates and anticipated China tariffs.

Store and Distribution Expense

• Stores and distribution expense include store payroll, store management, rent, utilities, and other related expenses
• Store expenses have consistently declined since 2015, falling from $1.60 billion in 2015 to $1.54 billion in 2018.
• This decline can be attributed to the deleveraging effect from higher net sales and expense reductions within store occupancy expense, resulting in a decrease in store occupancy expense, partially offset by higher direct-to-consumer expenses.
• The metric is expected to fall from 43.0% in 2018 to 42.2 % in FY 2019 as the company continues to optimize its fleet size and selling square footage.

Marketing, General, and Administrative Expenses

• Marketing, general and administrative expenses include compensation, photography and social media, store marketing, amortization related to trademark assets, relocation, recruiting and travel expenses among others.
• Marketing, general and administrative expenses as % of revenue have been constant around 13.5% over the last few years and we expect this metric to marginally decline to 13.2% in 2019 primarily due to expense reduction efforts and the leveraging effect from higher net sales.

Asset Impairment and Other Expenses

• Asset impairment and other expenses have not exceeded 1% of total revenues over the last few years. However, we expect this metric to rise to 2%  in 2019.

Additional details about how Abercrombie’s Other Expenses as well as Tax Payout have trended are available in our interactive dashboard.

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