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Abercrombie & Fitch (NYSE:ANF) is moving to new international frontiers to expand its business. The retailer will enter the U.A.E, Australia and Japan with its value focused Hollister brand. [1] In the U.A.E, per capita spending on apparel is the highest in the developing world, which could be a major incentive behind the company’s foray in this market. Japan and Australia provide good potential for value-focused products and we expect Hollister to perform well here. In the long term, if the retailer continues its expansion in these markets along with China, there can be moderate upside to our price estimate.

What Makes Hollister A Viable Expansion Option?

Compared to its premium brand ANF, Abercrombie offers Hollister products at relatively lower price points. This brand has an elaborate pseudo history based on the adventures of John M. Hollister, which gives it a unique meaning that appeals to many customers. Moreover, Hollister stores are smaller in size compared to ANF stores and thus their capital expenditures are lower. Together, these aspects make Hollister a viable option for international expansion.

What Do These Markets Offer?

United Arab Emirates: Abercrombie will open its first Hollister store in Dubai, which has become a hub for foreign retailers. [1] A report by consulting group AT Kearney stated that the U.A.E has the highest number of international retailers. [2] This can be attributed to the local population’s high disposable income and fashion consciousness. The same report suggested that the region’s annual per capita spending on apparel sales ($785 in 2010) is the highest among all the developing markets. [3] Although the country’s total apparel market is still small ($5.8 billion), it has grown at a healthy compounded annual growth rate (OTCPK:CAGR) of 7.6% during the last four years. [4] Abercrombie’s success here will position it well in the Middle East, which currently houses three of the five fastest growing apparel markets in the developing world. [2]

Japan: Although Japan’s apparel market stands large at about $110 billion, its growth has suffered due to a decline in consumer spending and prolonged economic weakness. [5] However, the situation is getting better with the Japanese government’s Cool Biz campaign and the consumer shift to value-focused products. [6] The government urged the companies to limit air conditioning and set warmer room temperatures, which resulted in increased demand for casual clothing suited for such an environment. [7] Japanese buyers have started to prefer long-lasting value-focused products. This is good news for Abercrombie as its Hollister brand offers clothing at lower prices compared to ANF. We believe that the retailer can establish a strong brand identity in the region.

Australia: Australia’s apparel market is relatively small and has been reeling under the impact of the global financial crisis. The market has been shrinking for the past few years, amounting to an estimated $12 billion in 2012. This decline could continue in 2013 as well. [8] Also, the discretionary spending in the region has been reduced and the online retail market is still at a nascent stage. [9] Australian consumers have become extremely conscious about their spending and are buying low- and medium-priced products. Although this might help Hollister’s sales, we expect the growth to remain slow.

The Significance Of This International Expansion

Abercrombie currently operates about 107 Hollister stores in international markets with most of them situated in Europe. [10] Over the last two years, the retailer has opened 69 Hollister stores internationally.

According to our current estimates, Hollister’s store count could increase by 70 over the next five to six years. However, with the company’s recent decision to enter new markets, the expansion pace could pick up. If we assume that the retailer will open about 20 Hollister stores annually for next several years with international markets operating at higher productivity compared to the U.S. (as is the case with Gap), there could be 5%-10% upside to our price estimate.

Our price estimate for Abercrombie & Fitch Stands at $51, implying a premium of about 5% to the market price.

Disclosure: No positions.

Source: Abercrombie & Fitch: Upside Potential With Hollister's Expansion Abroad