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Abercrombie (ANF) Witnesses Balanced Risk-Reward: Stock Down

Zacks Equity Research

Abercrombie & Fitch Company ANF has displayed significant strength in battling the odds in the apparel and shoes space. The company’s success can be attributed to its endeavors to expand digital and omni-channel capabilities, store fleet optimization, and focus on the Hollister brand. These efforts have not only helped it deliver a positive bottom-line surprise but also cushioned the stock in a tough environment.

Although the Abercrombie stock has declined 26.2% in the past year, it fared better than the industry’s fall of 42.5%. This illustrates the company’s potential to overcome the odds in the broader industry.

 



On the negative side, the company has been grappling with soft margins due to higher costs and a highly promotional retail environment in the United States. Further, its soft outlook for fiscal 2019 due to the anticipated impacts of the recently enacted tariffs is concerning investors.

Despite these headwinds, let’s see how well this specialty retailer of premium, high-quality casual apparel is placed to boost its momentum.

Factors Favoring the Stock

Abercrombie is making significant progress in expanding digital and omni-channel capabilities. The company’s investments in mobile, omni-channel and fulfillment significantly aided the growth of its digital business. Notably, digital engagement with consumers has been its core strength. The digital business continued to perform well, backed by robust momentum across brands and geographies. Digital sales improved in the double-digit range in second-quarter fiscal 2019. Notably, the business reached a key milestone of crossing the $1-billion mark in annual sales in fiscal 2018.

Further, the company is progressing well on its goal of delivering integrated digital and in-store shopping experiences. The company’s ‘purchase online, pick up in store’ (POPinS) and ‘order in-store’ capabilities are delivering strong results.

Additionally, the company is closely working on goals to optimize store fleet, which has resulted in significant store closures over the past eight years. However, it considers the closures as opportunities to improve store productivity by reducing store occupancy costs. In fact, global store optimization is a key component of the company’s efforts to ensure operating margin expansion and achieve the goals for fiscal 2020.

As part of its continued focus on optimizing store fleet, Abercrombie announced plans to close three additional flagships. Apparently, it shut Hollister SoHo in the fiscal second quarter, marking the first of the three planned flagship closures. The other two are Milan A&F and Fukuoka A&F, which are expected to be closed by the end of fiscal 2019 and 2020, respectively. Moreover, it expects to shut about 40 stores by fiscal 2019.

Simultaneously, the company’s investments in enhancing store experiences mainly through new store prototypes, remodeled stores and right-sizes should bode well. In fiscal 2019, it plans to deliver about 85 new experiences, up from 67 delivered in fiscal 2018.

Brand-wise, Abercrombie is poised to gain from the expansion of its Hollister stores in the newer international markets, which has been aiding overall performance. In second-quarter fiscal 2019, net sales improved 1% at Hollister, reflecting consistent momentum at the guys category, which was somewhat offset by softness in the girls category. Notably, Hollister’s marketing efforts are resonating well with customers’ requirements. Moreover, management remains confident about the brand’s prospects in the second half of fiscal 2019.

Factors Hurting Sentiment

Though the aforementioned factors keep us optimistic about the stock’s potential, there remain some hurdles in its growth path. The most prominent among these is the company’s soft margin trend, which is likely to continue. Further, a tough tariff environment is creating a major hurdle.

Abercrombie’s gross margin in second-quarter fiscal 2019 was impacted by higher average unit costs due to adverse product mix and a marginal fall in average unit retail as well as increased promotion and markdown costs. Meanwhile, operating margin was marred by adjusted operating expenses — including an unfavorable impact of the exit charges of a flagship outlet. Quite apparent, Abercrombie incurred loss in the trailing two quarters.

Additionally, the company assumes that the impact of List 3 and List 4 tariffs should hurt near-term results. The tariffs are likely to have an adverse impact of about $6 million on the company’s cost of goods sold and gross profit in fiscal 2019.

In fiscal 2019, it expects gross margin to decline 50-90 basis points (bps) from 60.2% recorded in fiscal 2018. The downside can be attributed to combined unfavorable impact of currency and expected tariffs of about 60 bps. For the fiscal third quarter, gross margin is likely to decline nearly 100 bps from 61.3% reported in the third quarter of fiscal 2018. Currency headwinds and anticipated tariffs to the tune of 90 bps primarily resulted in the downturn.

Wrapping Up

The above discussion clearly shows that Abercrombie has balanced risk-reward, with growth efforts likely to offset the near term hurdles. The company expects to mitigate the impacts of the recent tariffs through lesser imports from China. Notably, Abercrombie expects merchandise imports from China in the current fiscal year to be less than 20%, down from 25% last fiscal.

Further, the Zacks Rank #3 (Hold) company’s expected long-term earnings growth rate of 15.3% and a VGM Score of A speak well of its growth potential.

3 Key Picks in the Retail Space

Zumiez Inc. ZUMZ, with long-term earnings per share growth rate of 12%, currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Tilly's, Inc TLYS has a long-term earnings growth rate of 11% and flaunts a Zacks Rank #1 at present.

Genesco Inc GCO, also a Zacks Rank #1 stock, has an impressive long-term earnings growth rate of 5%.

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