Why Abercrombie & Fitch Could Warn in 3 Weeks

July 10, 2012 11:12 AM | 3 min read | Make a Comment
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Abercrombie & Fitch's
ANF
remaining shareholders have sure had it tough with a stock down 32% in 2012, a significant degree of underperformance relative to the S&P Retail Index and the broader consumer discretionary sector. The reasons for the hammering are in plain sight:
  1. slowing consumer spending
  2. 30% of annual sales are now running through the international arm
  3. very poor overall execution, including ill-timed international flagship store openings and an out of whack inventory to sales ratio.
    4. With recent analyst activity bordering on uber zany (Piper Jaffray reiterated its Overweight today yet estimates were slashed and along with the price target... to $50.00) someone had to call a spade a spade. I will gladly “go there.” The way I think about Abercrombie & Fitch is that it's sitting on a fairly strong earnings warning for the fiscal year due to a number of factors, making it hard to warm to the stock even as it's less than halfway to its 2009 low. Investors would be wise to seek returns in retail elsewhere if unwilling to head my reiterated negative sector stance (two long ideas I am keen on are Dollar General DG and Foot Locker FL). Why Abercrombie & Fitch is Likely to Warn in Early August Consensus is being blinded: The consensus currently expects Abercrombie's earnings per share growth rate to clock in at 50 percent for 2012 and then decelerate to a still energized 20 percent plus in 2013. These are unrealistic bottoms-up analyst estimates that ignore the macro impact on Abercrombie's international business (namesake flagships, Hollister mall stores, rising China exposure, cannibalization). I expect two things to occur:
    • fiscal year guidance to be revised below the low-end of the $3.50-$3.75 per share outstanding
    • cautious comments on the long-term operating margin guidance offered back in 2011
    Recall that on the first quarter earnings call, Abercrombie's guidance was “notwithstanding lower sales expectations.” Clearly, the microenvironment is rendering that viewpoint outdated. Ill-timed store openings hurt economics. At first quarter end, Abercrombie opened a flagship store in Hamburg. In August, an Abercrombie flagship is set to open in Hong Kong, and by year end there will be another location in Germany. The timing could not be worse from a demand perspective. With demand softening, it will only accentuate pre-opening expenses and pricey rent outlays on these hulking shrines to teen prep wares. Guidance ins and outs: fiscal year guidance was modeled on no further slowing internationally from the first quarter sales run rate. Umm yeah. Second quarter results: gross margin was guided to be down slightly year over year with modest expense de-leverage. Given the factors expressed here, in addition to intensification in promotions of late, these projections are at risk. Miss the mark on the second quarter, guidance will have to be revised lower (even easier cotton comparisons won't save the range). Inventory in a bad place: Abercrombie exited the first quarter with inventory higher by 44 percent - higher than planned - and reflective of weaker than anticipated sales. If Abercrombie worked through its excess goods successfully in the second quarter (there were signs of this), it was at sharper price points than envisioned given increased competitive pressures amid a consumer pullback. Hence, second quarter guidance is at risk: and by extension, so is the fiscal year. If inventory continues to be elevated by the conclusion of the second quarter, a more aggressive stance to clear goods before for back to school will emerge - plus, management may price more competitively for the season. Currently, management expects average unit retail prices to be "slightly" higher for the back half of the year.
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