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Abercrombie & Fitch Shares Surge 25%: A Successful Turnaround?

By Joseph Gacinga – Mar 19, 2014 at 10:43PM

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Abercrombie & Fitch shares have seen a huge year-to-date gain of 25% after the teen-clothing retailer showed solid signs of recovery. The company's price alignment and ongoing restructuring efforts should help it see much better sales and profits in the current fiscal year.

You can always trust the retail space to deliver the unexpected, which sometimes borders on the sensational. At a time when Wet Seal (NASDAQ: WTSL) investors are reeling from the shock of the huge sell-off of its shares, Abercrombie & Fitch (ANF -2.73%) investors are celebrating after the teen clothing retailer posted a profit, albeit a thin one, for the first time in several quarters. The company's shares have gained 25% this year, far more than the S&P 500's 1% gain.

Abercrombie & Fitch's huge gain in just over two months has not come from improving industry trends. Its peers have mostly recorded tiny gains, or seen considerable drops. Tilly's shares have gained 0.4% year-to-date, The Buckle (BKE -1.29%) has dropped 14%, American Eagle Outfitters has risen 0.2%, while Wet Seal shares have lost a shocking 29% so far this year.

Abercrombie saw share price gains because of its improving sales, and the announcement that it had finally agreed to introduce lower price points to compete more effectively with low-cost teen apparel retailers such as Hennes & Mauritz, Forever 21, and UNIQLO.

Unfavorable industry trends
Wet Seal investors seem to have lost all confidence in the company after it issued its fifth downward earnings revision in the space of just 12 months, with not a single upward revision issued. In the current quarter, the firm has issued three downward earnings estimate revisions, from an expected loss of $0.16  a share to $0.24 a share.

The company's comp-store sales is expected to decline in the high-single digits or low-double digits in the current quarter.The fashion retailer certainly seems to have hit a rough patch, and with the continuing lower revenue and earnings revisions, doesn't look like it's going to find its footing anytime soon.

The story is not much better at The Buckle. The company posted fourth-quarter fiscal 2013 revenue of $339 million, considerably lower than consensus estimates of $361 million. Its net income also fell from $61 in the year before comparable quarter to $59 million. Revenue for the full year came in at $1.13 billion, a slight improvement over the previous year's revenue of $1.12 billion. Net income for the full year dropped slightly from $164 million in fiscal 2012 to $163 million in fiscal 2013.

Therefore the fashion retail space seems to be generally chugging along laboriously, and any positive news is viewed by investors as a breath of fresh air. That's why Abercrombie & Fitch's small profit excited investors so much after a series of quarterly losses.

Abercombie makes price concessions
Abercrombie has been facing tough competition from the likes of Forever 21 and H&M, which sell trendy low-cost teen apparel. Abercrombie has for a long time been unwilling to change its intransigent position on its price points to reflect industry changes, reasoning that doing this would lower its pricing power and thereby cut its brands' gravitas in the eyes of its customers.

This does not come as a surprise to anyone, given how highly the company's Hollister brand is regarded by customers. However, the retailer's stubborn emphasis on uncompetitive price points has led to a roller coaster of downside surprises to unit volumes as well as excessive inventory levels, which have forced the company to resort to heightened promotional activity. The overall effect has been lower-than-expected sales.

Now Abercrombie has finally given in to pressure and agreed to lower its average unit cost, or AUC, in order to regain competitive flexibility. This will help the retailer compete more effectively with its more-nimble peers and, hopefully, see more revenue growth in the coming quarters.

Earnings beat
Abercrombie chief executive Mike Jeffries is famous for his straightforward, unabashed candor, which can sometimes go overboard, like his recent comment that heavyset customers need not shop at his stores. Although Mr. Jeffries, 69, was recently stripped of his role as company chairman after a series of results that had turned the revered teen retailer into a no-trick pony, he might still be around long enough to see the company get back firmly on solid footing.

Abercrombie seems to be recovering from its sales slump (it saw an 18% drop in the third quarter of 2013), and it reported sales of $1.3 billion and a GAAP net profit of $66.1 million, or $0.85 per share, in the fourth quarter of fiscal 2013. Comparable direct-to-customer sales improved 24%. Although net sales were down 12% from the previous year's comparable quarter, while net income was 58% less than that of the same period, it was a considerable sequential improvement since the company had reported net sales of $1.03 billion and a GAAP net loss of 15.6 million, or a $0.20 net loss per share, in the third-quarter. Abercrombie's flagship Hollister brand contributed more than half of its sales.

For the full year, Abercrombie reported a GAAP net income of $54.6 million, down from $237 million for the 2012 fiscal year. Earnings per share came in at just $0.69, well below the consensus estimate of $1.14 per share.

Better-than-expected outlook
Despite a dismal 2013, Abercrombie is a lot more optimistic about its prospects in the current fiscal year. It expects its diluted earnings to fall in the $2.15-$2.35 range, while it expects its comparable direct-to-consumer sales to grow 20%. The company also announced an $150 million share-buyback program.

Going forward, Abercrombie should be able to recapture market share since its Abercrombie & Fitch and Hollister brands are still quite popular with the younger generation. Its prices will also become more competitive and more in-line with those of its peers.

Foolish bottom line
Abercrombie seems to be on a firm recovery path from its past mis-steps. Although there is still some work to be done before the company returns to the giant it once was, the execution of its long-term plans and objectives should help the company generate meaningful improvement in its business, and create significant value for its shareholders.

Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends The Buckle. The Motley Fool owns shares of Staples and The Buckle. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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