Abercrombie (ANF) Stock Tumbles Despite Solid Q2 Earnings

Abercrombie & Fitch Co. ANF reported second-quarter fiscal 2018 results, wherein both the top and bottom lines improved year over year and the latter marked its fifth consecutive beat. Despite these factors, shares of the company tumbled 17.2% yesterday, which could be attributed to Abercrombie & Fitch’s first sales miss in more than a year now.

Per sources, sales and comparable store sales (comps) were hurt by underperformance of the Hollister brand, which sold out its summer clothes too early this year due to an exceptionally hot summer in Europe. Also, soft demand for the company’s namesake brand’s teenage apparel and Hollister’s surfwear were deterrents. Though comps and sales improved year over year, the rate of growth marked a sharp deceleration from the previous quarter. Additionally, the company’s international performance showed a decline from the previous quarter on both comps and sales fronts, whereas results remained strong in the United States.

We note that yesterday’s downfall has taken the company’s past three-month stock price performance to a decline of 4.7%, against the industry’s growth of 13%. Nonetheless, this Zacks Rank #3 (Hold) company is committed toward initiatives like strategic capital investments, cost-saving efforts, and loyalty and marketing programs to enhance its performance.

Q2 Earnings & Sales

The company posted adjusted earnings of 6 cents per share, against the Zacks Consensus Estimate of a loss of 5 cents as well as the year-ago period loss of 16 cents. On a reported basis, the company delivered a loss per share of 6 cents, narrower than the year-ago period loss of 23 cents.

Abercrombie & Fitch Company Price, Consensus and EPS Surprise
 

Abercrombie & Fitch Company Price, Consensus and EPS Surprise | Abercrombie & Fitch Company Quote

Bottom-line results gained from an increase in comps, gross margin growth and lower expenses, which reflects the company’s successful execution of playbooks. Further, currency tailwinds of roughly 1 cent per share (net of hedging) aided results.

Net sales of $842.4 million fell short of the Zacks Consensus Estimate of $847 million. Notably, sales advanced 8% year over year compared with an 11% increase in the previous quarter. During the second quarter, calendar shift and positive currency movements contributed nearly 4% and 1% to the sales increase, respectively.

Brand-wise, net sales improved 12% to $500.8 million at Hollister, while sales for the Abercrombie brand rose 3% to $341.6 million. We note that Abercrombie’s growth rate was much lower than the previous quarter, wherein its sales rose 7%. From a geographical viewpoint, net sales grew 13% and 1% in the United States and international markets, respectively, compared with 10% and 12% growth witnessed in the previous quarter.

Well, the company’s direct-to-consumer (DTC) business continued to perform well, backed by robust performance by both brands across the United States as well as internationally. Markedly, DTC sales surged 16% and accounted for nearly 26% of total sales in the quarter, whereas DTC comps grew 11%.

Comps in Detail

Comps increased 3% this quarter, trailing the previous quarter’s growth of 5%. Brand-wise, Hollister and Abercrombie brands posted comps growth of 4% and 2% compared with the previous quarter’s growth rates of 6% and 3%, respectively.

Nonetheless, management stated that the company’s comps growth was buoyed by strength in the United States, wherein comps increased 7% on the back of improvements in both brands. Further, U.S. comps growth reflects the company’s focus on product alignment, playbook execution, boosting traffic and conversion, and enhancing brand health metrics.  On the other hand, comps dropped 4% for the international region as strength in Asia was offset by soft comps in Europe. Comps in Asia were backed by strong digital business and gains from Tmall.

Margins

Gross margin expanded 110 basis points (bps) to 60.2%, courtesy of reduced costs incurred on like-for-like items in some of the high-volume seasonal items. Also, lower AUR and AUC stemming from department mix fueled gross margin expansion. Gross profit margin jumped 70 bps on a constant-currency basis.

Abercrombie reported adjusted operating income of $8.9 million, substantially better than adjusted operating loss of $15 million recorded in the prior-year period.

Other Financials

Abercrombie ended the quarter with cash and cash equivalents of $581.2 million and gross borrowings under its term-loan agreement of $253.3 million. As of Aug 4, 2018, inventories were $454.9 million, down 3% from the prior-year period.

On Aug 23, the company declared a quarterly dividend of 20 cents per share on the Class A shares. This is payable on Sep 17 to shareholders of record as of Sep 7.

Further, the company bought back 1.0 million shares for nearly $25 million in the second quarter. It had about 4.8 million shares remaining to be purchased under its current authorization.

Store Update

Management expects to introduce 22 full-price stores in fiscal 2018, including 13 Hollister and nine Abercrombie stores. Moreover, it plans to shut down up to 60 stores in the United States in fiscal 2018, through natural lease expirations.

Outlook

Abercrombie’s customer-centric approach, efforts to strengthen brands and focus on transformation endeavors are likely to help it achieve its targets for 2018 as well as for the long term.

For fiscal 2018, the company estimates both comps and sales to be up 2-4%. Favorable foreign currency rate is now expected to contribute nearly $20 million to net sales compared with $50 million anticipated earlier. In fact, currency movements are expected to serve as a headwind to the tune of nearly $15 million in the second half of the year. Loss of an additional week is expected to hurt sales by $40 million in fiscal 2018.

The company expects gross margin to improve slightly from 59.7% recorded in fiscal 2017. The upside will stem from higher average unit retail, including currency gains, reduced promotions and a slight decline in average unit costs.

GAAP operating expenses are now expected to increase nearly 2.5% from $2 billion adjusted operating expense recorded in fiscal 2017. Earlier, the company had projected a 2% increase.

Furthermore, the company expects effective tax rate to be in mid-to-upper 30s.

Additionally, the company envisions capital expenditures to be roughly $135-$140 million for fiscal 2018. This will include $85 million for store updates and new stores, and nearly $50-$55 million for direct-to-consumer and omni-channel investments, information technology and other projects.

For the fiscal third quarter, the company anticipates sales to remain nearly flat year over year including foreign currency and calendar shift impacts. Operating expenses are likely to increase 2-3% from fiscal 2017 and adjusted non-GAAP operating expenses are anticipated to be $489 million. The company expects effective tax rate to be in mid-30s.

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