Recovery Chances Slim For Abercrombie & Fitch

May.28.13 | About: Abercrombie & (ANF)

When Abercrombie & Fitch (NYSE:ANF) CEO Michael Jeffries spoke on the company's first quarter earnings last week, he boasted about earnings per share improvements and better than expected gross margins. As he and other members of the top brass droned on about the results, one topic that was unaddressed was how the company is dealing with public relations nightmares.

Most retailers suffer through some kind of embarrassing public relations snafu at sometime during their existence. They usually are willing to pull out all of the stops to quash the matter. It especially behooves publicly-traded retailers to get out ahead of negative news because the ramifications of not doing so can have disastrous effects on their top and bottom lines.

This seems to be lost on the execs at ANF, where many of the PR mishaps are self-inflicted. Take Jeffries comments where he's tried to rationalize why his brands didn't come in sizes larger than 10 for women. To add insult to injury, he's thrown in comments about how "cool" kids wore his clothes, as all kids want to be fit in with the so-called in crowd.

Latest Quarterly Report

Last week, after the company reported earnings for the first quarter, its stock sold off sharply. To get an idea of how sharply, consider this. The average volume of shares (over a three-month period) is just under two million, but on Friday, more than 10 million of its shares changed hands. The stock closed down more than 11%. The last time it suffered such a dramatic drop was in August when it fell about 14%. The main reason for that drop was the same as the main reason for last week's decline - guidance from the company that was less than anticipated, as well as a significant drop in sales.

While comp store sales fell during the first quarter, most troubling about the drop is that it includes just about all of the top revenue generators. Direct-to-consumer operations, along with online sales, were among the losses that contributed to the company's U.S. sales drop of 17%. They totaled $535 million. Even more troublesome is that its direct-to-consumer business is supposed to be one of the most valuable parts of ANF's business. Revenues were growing an average of about 35% in 2010 and 2011. Growth tapered of during the fourth quarter of 2012, and completely went in the wrong direction during the first quarter of 2013.

Blame It On The Weather

Among the issues ANF's top brass chalked up the dismal quarter to related to the weather and inventory. I find problems with both. I'll start with the weather by pointing out that serious weather issues were restricted to the Northeast. Given ANF sells its brands globally, this region of the U.S. should not have caused sales to tumble 17%.

That brings me to the company's inventory problems. These problems stem from the company's mismanagement of its products, and it seems to be becoming a trend. To its credit, the company tried to get a handle on this "by increasing its inventory at a much slower pace than the sales growth," noted Nasdaq.com. Furthermore, ANF continued this effort in the fourth quarter "with a low carryover of fall inventory," also according to Nasdaq.com.

In light of the pressures that the problems can have on the company's margins, during the earnings call last week, Jeffries had this to say about inventory:

… we feel pretty good about our current inventory position. And we think we're going to be in a very good position by back-to-school. But most of those inventory headwinds we had are behind us, so we feel we're pretty close to having the right levels of inventory today and that means that our normal flow cycle should work as we would plan for them to do.

Despite this better positioning, ANF's guidance was still lower than what the street had expected. Based on a "modestly more cautious" view for the remainder of the year, the company now expects full year diluted earnings per share to be in the range of $3.15 to $3.25. This projection assumes comparable sales, including direct-to-consumer, are projected to be slightly down for the balance of the year. With regard to the second quarter of fiscal 2013, the company expects diluted earnings per share to be in the range of $0.28 to $0.33.

Political Correctness Rules

Just as quickly as its stock fell sharply last year, ANF managed to recover - higher. It jumped to $41.92 on Nov. 14 from $31.18 on Nov. 13. That spike was due to the company announcing that its diluted earnings per share for fiscal 2012 would come in higher than analysts' estimates.

Per the company's own guidance, as well as the fallout from this latest PR snafu, the company won't rebound that quickly this time. What's most noteworthy is that the comments were made more than a half dozen years ago! Still they have come back to haunt the company with a vengeance. Jeffries seemed caught off guard, failing to deliver a redeemable apology. I have no doubt that the resurfacing of comments that he made so long ago are resonating throughout the investing and trading communities.

Jeffries has made such crass statements for years, never mincing words when it comes to who he wants wearing his clothes. Not even when the company's risqué advertising spurred massive public outcries did Jeffries even wince.

The market shrugged this off, which is reflected in the stock managing to grow in value, except when earnings missed estimates. The stock had managed to stay in the $40 to $50 range, and within striking distance of hitting a new 52-week high.

However, consumers had already started going to ANF competitors like American Eagle Outfitters (NYSE:AEO) that have similar goods, but for cheaper prices. Total returns for American Eagle Outfitters are up 9.35% over the last year versus the S&P 500, which is up 28.04%.

Now, in the age of social media and political correctness, insensitivity is intolerable. For Jeffries, and the once extremely popular Abercrombie & Fitch label, the ramifications of PR nightmares stemming from this are more weighted and investors are taking notice.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.