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Shares of apparel retailer Abercrombie & Fitch (NYSE:ANF) rose by 5% after it announced certain changes to its corporate governance structure. The company added three new members to its board and relieved CEO Mike Jeffries from his responsibilities as the Chairman of the Board. Jeffries, who will continue to hold the positions of Director and CEO, was under a lot of pressure, due to Abercrombie's weak performance and his negative publicity. The new board members (Arthur C. Martinez, Terry Burman, and Charles R. Perrin) are deeply experienced and they can ensure that the company moves in the right direction. Craig Stapleton, who will no longer serve as the independent lead director, stated that these changes were made mainly to address shareholder concerns. Soon after Abercrombie announced these changes, it promoted its CFO (Chief Financial Officer) Jonathan E. Ramsden to the position of COO (Chief Operating Officer).

Abercrombie, which was once the most sought after apparel brand, has been struggling to attract customers due to inventory issues, a lack of fashionable products and premium prices. Moreover, Mike Jeffries' comments regarding the company's target customer group has hurt its brand image. The CEO has also been scrutinized for the failure of Abercrombie's expansion strategies, and its Ruehl and Gilly Hicks brand.

While some investors wanted Mike Jeffries to step down, Abercrombie has decided to take away only the Chairman responsibilities from him. Sears' (NASDAQ:SHLD) ex-CEO Arthur Martinez will takeover Jeffries' role as chairman of the company. However, Mike Jeffries is still very much in control and Abercrombie's core problems are yet to be solved. The retailer's brand appeal has to improve to ensure recovery in the highly fashion sensitive U.S. apparel market. Abercrombie also terminated its stockholder rights plan to prevent a probable buyout in the future.

Our price estimate for Abercrombie & Fitch stands at $37.62, implying a premium of about 5% to the market price.

What Was Troubling Abercrombie?

During the first three quarters of fiscal 2013, Abercrombie registered a significant decline in its comparable store sales. This can be attributed to the company's poor inventory management, which prevented it from launching new products on time. Moreover, being a relatively expensive brand, Abercrombie failed to deliver popular merchandise last year as U.S. buyers scaled back their spending on apparel. Consumers shifted to low-cost and fast-fashion brands such as Gap Inc. (NYSE:GPS), Zara, Forever 21, H&M, etc.

Due to its weak financial performance, the retailer's stock price has decreased by more than 25% over the last year, which has raised concerns among its investors. A couple of months back, investment firm Engaged Capital scrutinized the company for its overbuilt U.S. store base and aggressive European expansion strategy. It also highlighted that the retailer's expensive brand failures - Ruehl and Gilly Hicks. The investment firm stated that poor leadership was more responsible for Abercombie's under-performance than weak asset quality. It also said that Mike Jeffries' public statements and the apparent intrusion of his private life in the company's business have caused unnecessary controversy, which is damaging the brand image, employee morale and likely sales. With rising pressure from investors, Abercrombie has finally decided to tweak its corporate governance structure.

These Areas Need To Get Better

While changes in the corporate governance structure can somewhat calm the rising shareholder concern, Abercrombie's financial performance still remains a worry. The company stated that the new COO Jonathan E Ramsden will be working closely with Mike Jeffries as well as individual brand presidents. They need to develop some of new strategies to elevate the retailer's brand image and regain customer confidence. To start with, Abercrombie's inventory management has to improve substantially. There have been a number of occasions in the past several quarters when the retailer faced either inventory shortage or surplus issues. For instance in Q1 fiscal 2013, the retailer did not have enough inventory to last the entire quarter, which dragged its comparable sales down by 17% (10% was due to low inventory). It's very clear that Abercrombie's executive management needs to do some serious work to strengthen its supply chain. If the company succeeds in doing so, it should become more responsive to changing fashion trends and seasons. This will position it better to compete with Forever 21 and H&M, which right now are cheaper and trendier than Abercrombie.

Lately, U.S. buyers have shown some affinity towards eccentric products as they want to add uniqueness to their lifestyle. Urban Outfitters' (NASDAQ:URBN) Free People brand has seen tremendous success over the past several quarters due to strong sales of its unique products. On the other hand, Abercrombie's merchandise is perceived as boring. A new line of edgy and preppy apparel might change this perception, or at least add some variety to the retailer's product portfolio.

Due to weak consumer sentiment in the U.S., expensive Abercrombie products haven't been very popular. Hence, the company needs to adapt to the sluggish economic environment to improve its store and web traffic. Abercrombie recently started offering plus sized clothes for women in response to media criticism over its "cool kids" controversy. We believe that providing its women buyers with excellent shopping experience and customer service will help the retailer mend its brand image.

The Company Eliminated Stockholder Rights Plan To Prevent A Takeover

In its letter to Abercrombie's board, Engaged Capital suggested the company to put itself up of sale if the CEO is not changed. However, it believed that Mike Jeffries' presence will be a major roadblock for the public-private transition. Now, as Jeffries has a Chairman of the Board above him, a financial or a strategic buyer might find it easier to acquire the company. The leanings and independence of the new board members will be key. However, Abercrombie has terminated its stockholder rights plan, suggesting that it has no intentions of going private.

Source: Abercrombie & Fitch Limits CEO's Responsibilities And Eliminates Its Poison Pill Plan