Abercrombie’s Hollister Brand Zooms Into Fast-Fashion Segment

More changes are on the way for Abercrombie & Fitch Co (ANF 0.95%). The company has laid out plans to reposition its Hollister chain as a fast-fashion brand, hoping to better compete with rivals such as H & M Hennes & Mauritz AB (HNNMY 0.66%) and Forever 21. These popular stores have succeeded in attracting away teenagers from Abercrombie's higher-priced merchandise.

This will mean lowering prices and beefing up U.S.-based supply sources to adjust more quickly to changing styles. The fast-fashion segment is very popular with teenagers with limited budgets. Fast-fashion stores, like H&M and Fast Retailing Co.'s (FRCOY) Uniqlo, sell their wares for less, making it easy for teens to shop often.

The Wall Street Journal reported that Arthur Martinez, Abercrombie's new chairman, said in an interview that the company is working with vendors to create a more responsive supply chain. The company is also looking to hire a president for the Hollister chain who has fast-fashion experience. The candidate should know how to speed up the merchandising cycle, which is the hallmark of the fast-fashion segment. This alone is expected to improve the company's other brands.

Abercrombie & Fitch's higher-priced basics have lost their appeal with the teen set, who are flocking to fast-fashion outlets that are doing a better job of catering to this demographic. During fiscal 2013, Hollister's almost 600 stores had a drop of 14% in sales, excluding new or closed stores. This drop was higher than the 10% sales decline at Abercrombie. Hollister pulled in about half of the company's sales, or $2.1 billion. The company has plans to close about 60 to 70 U.S. stores, and most of those closures will impact the Hollister brand.

Internal changes may delay improvement in earnings
Abercrombie's operational missteps have increased interest in replacing current CEO Mike Jeffries, who some believe may be an obstacle to selling the company. Jeffries was recently removed as chairman, and two new board members were added. However, replacing Jefferies is not a high priority for the board, according to Martinez, who has met with shareholder Engaged Capital LLC, which currently owns 0.5% of the company. Engaged Capital is looking at taking over five of the company's 12 board seats as it questions the board's decision-making ability. Currently, the search is on for two new presidents to run both the Abercrombie and Hollister brands.

Abercrombie's fiscal 2013 results fell short of expectations, despite EPS showing improvements exceeding estimates in the last two quarters of the year. The company reported fourth-quarter GAAP net income of $66.1 million, and net income per diluted share of $0.85. Fourth-quarter results for the period ended Feb. 2, 2013 saw GAAP net income of $157.2 million, and net income per diluted share of $1.95. The company's fourth quarter also saw higher merchandise discounts, and the gross profit rate dropped 440 basis points, to 59%, compared to fiscal 2012.

Fast-fashion competitors winning over the coveted teen segment
Meanwhile, sales at fast-fashion competitor H&M grew by 6% in local currencies during fiscal 2013. The company added more than 300 new stores during the year, predominately in China and the U.S. Gross margin was virtually unchanged during the fourth quarter of 2013 versus the same period in 2012. Gross profit increased 11% to deliver a gross margin of 60.8%. Sales rose by 10% and were estimated to rise 15% in December 2013 and January 2014. For fiscal 2014, an additional 375 new stores will be added, and that includes additions in new markets, like the Philippines and Australia.

The online business is growing in importance for H&M, and hm.com is one of the world's most visited fashion sites, according to the company. The company plans to open four new H&M online markets in 2014. Despite some headwinds, the company expects positive results for the current year, and new product lines have been received well by its customers.

Another fast-fashion powerhouse The Fast Retailing Group, had an increase in net income of 1.8% in the first quarter of fiscal 2014. The company's three divisions -- UNIQLO Japan, UNIQLO International, and Global Brands -- had higher net sales during the first quarter:

Source: Q1 FY2014 Results Summary

All three divisions have increased their number of stores, which translates into higher SG&A expenses by 29% year over year. The company has adopted a "scrap and build" policy, where smaller stores are being replaced with larger ones to boost the size of their sales floor space. The group, as a whole, generated significant gains in both sales and income in the first quarter of fiscal 2014. Consolidated net sales increased 22.3% year on year, and operating income rose by 13%. Group sales are expected to expand during the rest of fiscal 2014 by 15.7% year over year, and operating income should increase by 17.4%.

My Foolish conclusion
As Abercrombie repositions its Hollister brand to compete with its fast-fashion rivals, investors should expect the company to continue to struggle for the remainder of 2014. It's also unclear whether the Hollister brand will generate enough buzz to attract the teen clientele its rivals have successfully wooed. The company, for now, remains a work in progress, and investors may want to wait a few quarters if they want to add shares to their portfolios.