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Why Is Abercrombie (ANF) Down 9.4% Since Last Earnings Report?

Zacks Equity Research

It has been about a month since the last earnings report for Abercrombie & Fitch (ANF). Shares have lost about 9.4% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Abercrombie due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important catalysts.

Abercrombie Incurs Lower-Than-Expected Loss in Q1

Abercrombie reported solid first-quarter fiscal 2019 results, wherein top and bottom lines beat the Zacks Consensus Estimate. This marked the company's eighth consecutive quarter of positive earnings surprise while sales topped estimates in eight out of the last nine quarters. Moreover, the result reflected improvement from the prior-year quarter.

Q1 Earnings & Sales

Abercrombie incurred adjusted loss of 29 cents per share, narrower than the Zacks Consensus Estimate of a loss of 43 cents and adjusted loss of 56 cents reported in the year-ago quarter. On a reported basis, the company had incurred loss of 62 cents per share in the year-ago period. Earnings included an a negative impact of nearly 2 cents from unfavorable currency.

Net sales of $734 million marginally surpassed the Zacks Consensus Estimate of $733.5 million and inched up 0.4% from the year-ago quarter’s sales of $730.9 million. The top line gained from positive comps across both brands. Results included a negative impact of $16 million (or 2%) from adverse foreign currency rates.

Brand-wise, net sales improved 1% to $428.5 million at Hollister, while it dipped 1% to $305.5 million for the Abercrombie brand. From a geographical viewpoint, net sales grew 5% in the United States but decreased 6% in international markets.

Notably, Abercrombie’s digital business continued to perform well backed by robust momentum across both brands and geographies. Digital channel sales contributed 30% to revenues in the fiscal first quarter.

Comps in Detail

Comps increased 1% in the fiscal first quarter on the back of strong cross-channel traffic owing to the positive outcome of the company’s marketing initiatives and products. Brand-wise, comps increased 2% for Hollister and 1% for Abercrombie.

Notably, this marked the seventh consecutive quarter of comps growth for the company backed by continued strength in Hollister and return to positive comps at Abercrombie. The quarter also marked the 10th straight quarter of positive comps for Hollister. Meanwhile, the Abercrombie brand returned to growth, courtesy of positive trends in the women’s business.

Comps growth was mainly driven by strong performance in the United States, wherein comps improved 4%. This was partly offset by a 4% comps decline in international markets.

Margins

Gross margin remained flat with the prior-year quarter at 60.5%. Gross profit margin benefited from the clearing of most of the issues in the underperforming women’s tops and dresses categories at Abercrombie. Further, flat gross margin reflects fall in average unit retail (AUR), offset by lower average unit costs (AUC).

Abercrombie incurred adjusted operating loss of $27 million compared with a loss of $37 million in the prior-year quarter. Adjusted operating loss margin improved 130 bps from the year-ago quarter. Operating loss in the quarter benefited from 2% decline in adjusted operating expense, offset by $2 million negative impact from currency headwinds. Lower operating expense can be attributed to changes in foreign currency rates, decline in compensation expense, and reduced depreciation on store and IT assets.

Other Financials

Abercrombie ended the fiscal first quarter with cash and cash equivalents of $586.1 million, and gross borrowings under its term-loan agreement of $253.3 million. As of May 4, 2019, inventories were $432.6 million, reflecting 6.7% growth from the prior-year period.

Moreover, the company returned about $13.2 million to its shareholders through dividends in first-quarter fiscal 2019. At the end of the first quarter, Abercrombie had authorization worth nearly $3.6 million remaining under its current share repurchase plan.

On May 23, the company declared a quarterly dividend of 20 cents per share on the Class A shares. This is paid on Jun 17, 2019, to its shareholders of record as of Jun 7, 2019.

At the end of the fiscal second quarter, Abercrombie expects inventory to increase mid-single digits driven by an increase in forecasted in-transit inventory flow due to updates on its August and September floorset strategy.

Store Update

Abercrombie has been closely working on its goals of optimizing store fleet, which led to significant store closures in the past eight years. The company takes these closures as an opportunity to improve store productivity by reducing store occupancy costs. The global store optimization is a key component of its efforts to deliver operating margin expansion and reach its goals for fiscal 2020.

As part of its continued focus on optimizing store fleet, Abercrombie announced plans to close three additional flagships. These include Hollister SoHo in the second quarter of fiscal 2019, Milan A&F by the end of fiscal 2019, and Fukuoka A&F in the back half of fiscal 2020.

These, along with recent flagship closures – A&F Copenhagen closure this March and the Pedder Street, Hong Kong A&F closure in 2017 – will bring the company’s total flagship closures to five. Excluding the recent closures, the company still has 15 global flagships.

For fiscal 2019, the company remains on track to deliver about 85 new experiences through new stores, remodels and right-sizes.

Outlook

For fiscal 2019, the company estimates sales to increase 2-4%, driven by low-single-digit comps growth and comparable sales contribution from new stores. However, unfavorable foreign currency rate is now expected to mar top-line results by nearly $30 million, up from the prior view of $15 million impact.

The company expects gross margin to improve slightly from 50.2% recorded in fiscal 2018. The upside will likely stem from higher AUR, including adverse currency impacts, partly offset by higher AUCs. However, the guidance excludes potential impact of higher China tariffs on apparel.

Operating expenses, excluding other operating income, are now expected to increase nearly 4-5% year over year, compared with the prior view of 2% increase. The increase in operating expenses mainly reflects net lease-related charges of about $45 million (or 220 bps), due to the closure of the SoHo and Fukuoka flagships. Furthermore, it anticipates effective tax rate to be in mid-20s compared with mid-to-upper 20s range expected earlier.

Additionally, the company envisions capital expenditure of roughly $200 million for fiscal 2019, marking an increase from $152 million in fiscal 2018. This will likely include $120 million for stores, and nearly $80 million for digital and technology investments.

For the fiscal second quarter, the company anticipates sales to be flat to up 2% from the prior-year quarter. This includes an adverse impact of nearly $10 million from negative currency translations. Comps are anticipated to remain flat. Gross margin is likely decline nearly 100 bps from 60.2% reported in the second quarter of fiscal 2018. Lower gross margin will mainly stem from expectations of increased currency headwinds and promotional activity.

Operating expenses (excluding other operating income) are estimated to increase 10% from adjusted operating expenses of $498 million in second-quarter fiscal 2018. Excluding one-time charges in the prior-year quarter, adjusted operating expenses are likely to be flat to up 1%. Effective tax rate is anticipated in mid-20s.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed a downward trend in fresh estimates. The consensus estimate has shifted -805.09% due to these changes.

VGM Scores

Currently, Abercrombie has a nice Growth Score of B, though it is lagging a lot on the Momentum Score front with an F. However, the stock was allocated a grade of B on the value side, putting it in the second quintile for this investment strategy.

Overall, the stock has an aggregate VGM Score of C. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, Abercrombie has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.



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