Why Abercrombie's Earnings Came Up Too Short

Abercrombie & Fitch (NYSE: ANF  ) just saw a first quarter that came up too short for investors. Overall sales are down 8.9% and the company's stock price plummeted 8% immediately following its earnings release.

A dismal quarterly report almost seems like karma for Abercrombie -- it not only comes on the heels of the resurfacing of CEO Mike Jeffries' controversial 2006 comments about only wanting good-looking clientele, but also after news that Abercrombie refuses to produce clothing above a size 10. While the controversies may not have affected Abercrombie's sales this quarter, there are several reasons behind the first-quarter backslide. Let's take a look at the nitty-gritty of this struggling retailer.

Inventory
According to Jeffries, Abercrombie's first-quarter decrease in sales was largely due to a lack of merchandise. The CEO cited "more significant inventory shortage issues than anticipated," which included lags in deliveries for the company's spring 2013 line of clothing.

This incident is a complete reversal of fortune from Abercrombie's 2012, during which the company had far too much inventory on its hands and had to majorly mark down items. Jeffries believes the company is through the worst of the clothing shortage, though, saying, "with the inventory headwinds largely behind us, we expect to see continued sequential improvement in the second quarter."

Changing tastes of American teens
Abercrombie isn't the only trendy retailer that has just had a depressing quarter. One of its closest rivals, clothier Aeropostale (NYSE: ARO  ) , is also suffering. Aeropostale's stock sank 10%, even lower than Abercrombie's, following its earnings call, which revealed a 9% drop in revenue and a 14% decline in comparable-store sales. Seeing both companies suffer so similarly may lead some to wonder if teen tastes are starting to turn elsewhere.

This wouldn't be wholly surprising. In the past, companies like Abercrombie, Aeropostale, and even Urban Outfitters have excelled at capitalizing on the tastes of the American teenager. At its best, this demographic is a wildly profitable one, and at its worst, it is incredibly volatile, with no guarantee of continued brand loyalty.

Throwing millions of dollars into research and development can pay off in the short term, but inevitably these customers grow up, and so do their tastes. While this makes way for a new crop of teens (and thus fresh revenue), there's no way to predict with 100% accuracy what these new consumers will like, much less whether it will be at all similar to the previous generation's tastes. For the moment at least, stores like Abercrombie appear to be suffering at the wrong side of this gamble.

So what does it mean? 
Abercrombie isn't necessarily drowning, but its latest earning call might suggest that long-term investing in teen culture is a highly risky choice. If you can't tell whether the company will have its same customer base in 10 years, or even if its products will maintain their appeal in 10 years, you probably shouldn't trust it a chunk of your portfolio to it.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


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