Abercrombie & Fitch Q2 2014: Cool Kids No Longer Wear Logos

| About: Abercrombie & (ANF)


ANF beat on EPS but revenue miss reflects the ongoing diminishing brand value.

Cost management could support EPS in the near term.

Long-term execution relies on new product launch and promotion to recover comp sales.

Abercrombie & Fitch (NYSE:ANF) reported adjusted EPS of $0.19 that beat consensus of $0.11 mainly on well executed cost control. The revenue miss ($890m vs. consensus $909m) was a function of the ongoing weakness in comp sales (-7%) as ANF faces the challenges of its diminishing brand value. But signs of better than expected margins and inventory management are paving the way for earnings rebound. The decision to remove the ANF logo on most of its products is prudent and could improve comp sales in the future.

Less logo to drive future comps

US comps were -5% and international -9%. On the brand level, ANF comps were -1% y/y, with ANF kids -6% and Hollister -10%. The weakness in comps is due to the declining brand value of ANF and aggressive promotion to clear the inventory. However, the positive read-through due to back-to-school sale and less logo products going forward could be accretive to demand and comp sales.

Gross margin to be pressured but expect good cost control

I expect promotional activities will likely to be in place to draw shoppers back to the stores and to improve comp sales. Discount is necessary until a material rebound in comps can be achieved. However, I do not believe that gross margin will be as bad as the consensus expects as inventory improves and a new pricing strategy are in place. To offset the gross margin pressure, management will focus on cost cutting and has targeted $175m in cost saving this year and I see this achievable.

E-commerce, a bright spot

The company has invested a lot in e-commerce during the Q, namely setting up a new distribution center to expedite online order processes and introducing shipping from store feature. Next year, there will be in-store pickups. On the international front, ANF is focusing on setting up local website, opening stores on e-commerce sites (i.e. Alibaba) and setting up local fulfillment to expand e-commerce abroad, where ANF still has some appeal to shoppers of all age groups. This will be a critical growth channel for ANF.

Overall an in-line quarter given that the weak comp is expected but solid cost control is accretive to EPS. If the company can deliver on comps following the product change and boosting e-commerce sales, then we could see further EPS upside going forward.

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