Shares of Abercrombie & Fitch (ANF) witnessed a serious correction after the release of a very weak set of second quarter results, followed by an even worse outlook for the third quarter. While stock might be put on sale at a 20% discount overnight, it is too soon to go bargain shopping. The severity of the deterioration in operating performance more than warrants this sell-off and I don't think the stock will form a bottom at current levels.
Second Quarter Results
Abercrombie & Fitch generated second quarter revenues of $945.7 million, down 1% on the year before, thereby badly missing consensus estimates of $996.2 million.
Net income for the quarter came in at $11.4 million, down 33% on the year before. Earnings per share fell by six cents to $0.14 per share. Earnings include a $0.02 charge related to on-going profit initiatives.
Adjusted earnings of $0.16 per share missed consensus estimates of $0.28 by a wide margin.
CEO and Chairman Mike Jeffries commented on the second quarter performance. "The second quarter was more difficult than expected due to weaker traffic and continued softness in the female business, consistent with what others have reported. In that context we are planning sales, inventory and expenses conservatively for the remainder of the year."
Looking Into The Results
Clearly a 1% drop in net sales is extremely disappointing. The entire reason behind the shortfall is a 10% decline in comparable sales, even when including direct-to-consumer sales.
This compares to consensus estimates which predicted just a 2.5% fall in comparable sales. Worrisome, the weakest results were achieved in July, indicating the worst might not be over into the third quarter.
Notably weak was the 13% decline in Hollister same store sales, while comparable sales at Abercrombie & Fitch fell by 6%.
The online direct-to-consumer business continues to perform well, as revenues were up by 21% to $154.3 million, now representing 16% of total sales. Including direct-to-consumer sales, revenues fell by 8% in the US, while increasing by 15% in the international activities.
Gross margins were up by 160 basis points to 63.9% which is surprising giving the poor sales results. Perhaps the company could have been a bit more aggressive on pricing. Stores and distribution expenses rose by 180 basis points to 49.9% of total sales on the back of negative operating leverage and the decline of comparable sales.
Given the poor developments and visibility, Abercrombie sees third quarter comparable sales fall even more compared to the second quarter. Abercrombie guides for GAAP earnings of $0.40-$0.45 per share.
Abercrombie states that visibility is too poor, to provide any kind of outlook beyond the third quarter.
To put the guidance in perspective. In the third quarter last year Abercrombie earned $0.87 per share on revenues of $1.17 billion. Even worse, consensus estimates stood at earnings of $1.06 per share.
Abercrombie & Fitch ended the second quarter with $335 million in cash and equivalents. The company operates with $142.5 million in short and long term debt, for a net cash position of almost $200 million.
Revenues for the first six months of the year came in at $1.78 billion, down 5% on the year before. The company reported a $4.2 million profit, or $0.05 per share for the period.
Full year revenues could come in around $4.0-$4.2 billion according to my projections. Given the conditions, it will become challenging for Abercrombie to report earnings exceeding the $100 million mark.
Factoring in the 18% drop in Thursday's trading session, with shares exchanging hands at $38 per share, the market values Abercrombie at $3.0 billion. Factoring in the net cash position and operating assets are valued at $2.8 billion. This values the firm at roughly 0.7 times annual revenues and 28 times "depressed" earnings.
The quarterly dividend of $0.20 per share provides investors with a dividend yield of 2.1%.
Some Historical Perspective
Long term investors have mostly seen a great deal of volatility instead of returns over the past decade. Shares have risen from $25 in 2004 to a peak around $80 in 2007 as the US consumer was thriving.
Shares fell back to their twenties in the 2009 recession but sharply bounced back to approach $80 again in 2011. Ever since they have lost half their value again, exchanging hands at $38 per share.
Between the calendar year of 2009 and 2012, Abercrombie has increased its annual revenues by a cumulative 54% to $4.5 billion. After years of steady growth, revenues will most certainly fall this year. Profitability has risen from break-even levels in 2009 to earnings of $237 million over the past year.
The earnings report and comments by management have been an absolute shocker. While teen retail spending has come under pressure in general, the company has performed poorly in a weak environment.
It seems many teens are opting for cheaper clothing of multinationals such as Zara or Hennes & Mauritz. That being said, other retailers including Wal-Mart (WMT) and Macy's (M) have said the economic environment has grown more challenging in recent weeks.
Back in November of last year, I last took a look at the company's prospects. Shares saw an incredible jump upwards after a strong third quarter, and moved up to their low-forties. I urged investors to take profits based on valuation motives. Not only have shares missed out on the general market rally, they actually have fallen some 10% in the meantime.
While international store opening are still on the planning, this is entirely, or more than offset by store closures in the US. To tackle the current issues Abercrombie is embarking on a $100 million cost savings initiative. Still I am not impressed.
Even if the company manages to stabilize the operations and show some growth in 2014 and 2015, $5 billion in annual revenues seem to be the maximum achievable by the end of 2015. I don't see earnings surpassing the $200-$250 million mark at the same time, despite cost initiatives. With a current valuation of $2.8 billion for operating assets, investors are too early to go bottom-fishing if they would in today's market.
I would wait for a few weeks or months anticipating the stock to go lower into a dramatic third quarter.