Our rating on Abercrombie & Fitch Co. (NYSE: ANF) remains HOLD. ANF has taken steps to improve marketing, strengthen its omnichannel capabilities, and transition to smaller-format stores that can help boost customer engagement. While there were signs of improvement prior to COVID-19, we note that decelerating comp sales, increased promotional activity, weak store traffic, and trade war uncertainties threaten the company’s turnaround. ANF has also been hurt by weakness in Europe.
For fiscal 2Q21 (ended August 1, 2020), Abercrombie & Fitch reported a non-GAAP gain of $0.23 per share, versus a loss of $0.48 per share. The Street had expected a loss of $0.83 per share. Non-GAAP results excluded a COVID-related asset impairment charge of $0.15 per share.
Second-quarter net sales were $698 million, down 17% from the same quarter last year, and ahead of the consensus forecast by $44.8 million. The company did not report comparable-store sales due to store closures. It noted that global store productivity was at about 70% for reopened stores, and improved conversion helped offset the decline in store traffic. Online sales grew 56%, and total visits to the website and app increased more than 25% in 2Q.
Abercrombie & Fitch took a range of steps to maintain financial flexibility during the pandemic, including staff layoffs, executive salary cuts, temporarily suspended dividends and share repurchases, and reducing inventory. With 90% of global stores now open, payroll, variable store occupancy, and other expenses will increase; however the company continues to reduce fixed costs. Management withdrew its previously issued FY21 guidance due to coronavirus uncertainties, but estimated a 15%-20% decline in 3Q sales, in line with 2Q. Capital expenditures are expected to be $100 million for the full year, with about half going to stores and half to technology investments and maintenance.
The company continues to rationalize its store portfolio, which included 639 U.S. stores and 210 overseas locations at the end of 2Q. In 2019, it reduced total square footage by 4%. Its new stores feature a smaller footprint intended to boost customer engagement, and have shown increased traffic and improved productivity.
EARNINGS & GROWTH ANALYSIS
The company has two business segments: Hollister (61.5% of net sales) and Abercrombie (38.5% of net sales). Second-quarter results by segment are summarized below.
Hollister reported a 15% decline in net sales. Hollister outperformed A&F and kids globally; however, back-to-school adversely impacted the segment in the U.S. as schools delayed opening. Management said must-have and top-30 items outperformed, including Girls’ denim shorts, a very competitive category. In guys, multipack tees, graphics, swim and lounge shorts were the strongest performers. Gilly Hicks saw strong double-digit growth in 2Q, and over 100% growth in online sales. Online sales of loungewear in Gilly Hicks have performed well this year, and the newly launched Gilly Active brand. The segment has recently shown improvement in average unit retail, and improvement in conversion, and has benefited from its focus on enhanced assortment and inventory. Hollister continues to increase brand awareness through the use of influencer partnerships. Its back-to-school denim campaign in the second quarter featured TikTok stars Charli and Dixie D’Amelio. Other brand ambassadors include Noah Pugliano and Bill Nye; and recording artists Khalid and Noah Cyrus, who partnered in the ‘carpe denim’ campaign as part of an antibullying initiative aimed at its core Gen Z customers.
The Abercrombie segment (which returned to growth in 4Q17 following five years of negative comps) saw a 20% decline in net sales in 2Q. A&F Women’s business saw online sales grow double-digits in shorts, knit tops, skirts and swim. Tees, shorts, jeans and Fierce-its signature fragrance, were the top men’s categories; and in kids, shorts and swim were the top-performing categories. Prior to the pandemic, the segment was seeing better traffic trends and a higher average transaction value, with positive comps in the U.S. and internationally. The kids segment, which the company sees as an important growth driver, has also shown improvement.
Second-quarter sales were down in all regions, with declines of 16% in the U.S., 15% in EMEA, and 38% in Asia Pacific. Productivity in the U.S. was at 75% of last year, with an average of one-third of the days in the quarter closed due to the pandemic. Store productivity was at 60% of last year in EMEA, and in Asia productivity was about 70%.
Abercrombie has boosted customer engagement at Hollister stores through its Caliroyalty program, which was rolled out in 2Q16, and at Abercrombie through a new ambassador program and Club A&F membership program. Its loyalty clubs continue to grow, doubling from last year to more than 28 million members.
The company has been making strategic inventory investments and is offering clothing in a wider variety of colors and sizes.
Second-quarter adjusted operating expense as a percentage of sales declined 610 basis points to 57.8% including an adverse impact of 530 basis points related to flagship store closures, while shipping expenses rose on higher online sales. The 2Q gross margin was 60.7%, a 140-basis-point improvement from last year, driven by fewer promotions.
We expect 3Q sales down 16% from a year ago.
We note that the company has been reducing its exposure to products sourced from China. It is currently sourcing 22% of its merchandise from China, down from 25% last year, and looks to further reduce this to the low teens going forward. Management expects the company’s diverse supplier base in 17 countries to help mitigate the impact of tariffs.
FINANCIAL STRENGTH & DIVIDEND
ANF ended 2Q with $766.7 million. The company drew $210 million from its senior secured credit revolver and $50 million in excess cash from its Rabbi Trust. In 2Q, it issued $350 million of 2025 senior secured notes, which it used to fully pay down its term loan, a portion of the credit revolver, in addition to store fees.
ANF had paid a quarterly dividend of $0.20 per share, or $0.80 annually; however, it has temporarily suspended the dividend as well as share buybacks. ANF repurchased 4 million shares in FY20 and 1.4 million shares in 1Q21 prior to the pandemic. Management noted that it would review its dividend and share repurchase policies throughout the year.
MANAGEMENT & RISKS
In February 2017, the company named Fran Horowitz as CEO and Joanne Crevoiserat as COO. Ms. Horowitz had been president of Hollister since joining the company in October 2014 and chief merchandising officer since December 2015 – she is credited with improving comp sales at Hollister.
Arthur Martinez stepped down from his position as executive chairman at the end of FY17. Mr. Martinez had a distinguished career in retail, and is best known for saving Sears in the 1990s. Terry L. Burman, who joined the board in January 2014, assumed the role of nonexecutive chairman.
Scott Lipesky was recently named Abercrombie & Fitch CFO.
Kristin Scott, previously brand president of Hollister, was promoted to the new role of president, Global Brands, in November 2018.
To help redefine and broaden the appeal of its brand, Abercrombie hired an external creative agency and appointed a new chief marketing officer. We believe that its new marketing campaign, which promotes ANF as a ‘lifestyle’ brand, could help the company to capture additional market share.
Nevertheless, younger consumers tend to have less brand loyalty. In addition, apparel sales to younger consumers tend to be more seasonal, with higher sales in the second half of the year. Earnings can also be hurt if unseasonably warm weather forces the company to take markdowns on coats, sweaters and accessories.
Abercrombie & Fitch is a global mall-based clothing retailer. The company has three retail brands: Abercrombie & Fitch, which sells to teens and young adults; abercrombie, which sells to kids; and Hollister Co.
Given the company’s decelerating comp growth, along with weaker traffic trends and economic uncertainty, we believe that the outcome of the company’s turnaround remains uncertain. We would consider returning the stock to our BUY list if we see a clearer path to comp sales improvement and earnings growth.