Abercrombie & Fitch’s Quarter and Some Consistencies with Other Retailers

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I haven’t followed A & F as closely as I probably should. Too many companies (especially now that our market is something broader than action sports), not enough time. But A & E is the owner and originator of that iconic surf brand Hollister (heavy sarcasm). And especially after my recent post on cosmetics and skateboarding where I got into core versus having fun and giving consumers what they want, A & E seemed worth a look. 

Some of management’s comments in both the 10Q and the conference call also reflected concerns and strategies similar to other retailers I’ve recently reviewed and I wanted to call those out. I think maybe they are all reacting to trends that are going to become obsolete over the medium term. We’ll see.
 
I’m going to start with the October 27 quarter numbers, because you need them as a background to understand some of management’s comments. Sales rose 9% to $1.17 billion from $1.076 billion in the same quarter last year (foreign currency issues had a negative $7.9 million impact on sales). Cost of goods sold grew hardly at all, while gross profit rose $647 million to $732 million.
 
Obviously, the gross profit margin rose for that to happen- from 60.1% to 62.5%. It’s increase was “…primarily driven by a decrease in average unit cost and an international mix benefit, partially offset by a slight decrease in average unit retail and the adverse effect of exchange rates.” I think what they mean to say is that the price of cotton came down.   
 
Other expenses as a percentage of sales didn’t change much in aggregate, so those higher sales and gross margin improvements went right to the bottom line. Net income rose 40.5% from $50.9 million to $71.5 million. I should point out that for the three quarters ended October 27, A & E’s net income was down from $108 million to $90 million due to some issues with inventory and not being on trend as well as general market conditions.
 
A & F has four kinds of stores; Abercrombie & Fitch, Abercrombie (kids), Hollister, and Gilly Hicks. During the quarter, comparable store sales fell 3% after being up in 7% in the quarter last year. For nine months, comparable store sales are down 6% after being up 8% in the same period the previous year. Hollister, down 1%, was the best performing segment.
 
Hollister’s revenues rose from $518 to $602 million during the quarter. Abercrombie & Fitch stores rose only slightly from $436 to $440 million. Abercrombie stores fell $4.4 million to $100 million. Gilly Hicks revenues were up from $17.6 to $27.3 million, but you can see they are small as a percent of the total. Hollister accounted for 52% of total quarterly sales and without their growth it wouldn’t have been much of a quarter.
 
How did they get the 9% sales increase when comparable sales were down 3%? On line sales rose from $132.4 million to $158.3 million, and from 12% to 14% of total sales. And they opened 12 new international stores of which nine were Hollister. They did not open or close any stores in the U.S.
 
U.S. store sales fell from $725 to $709 million. International store sales were rose from $215 to $299 million (Obviously mostly Hollister). Operating income on the U.S. stores was $162.4 million, or 22.9%. For international stores, it was 29.16%.
 
For on line, it was 44%. That would certainly get my attention.
 
Okay, on to some of the common issues among retailers. I guess it’s obvious that the first one is on line business. There’s a lot of it, it’s growing, and it’s very profitable. The thing I don’t know, and I’ve asked the question before, is whether it is cannibalizing in store sales or helping them. We all hope and want to believe that there’s some strategy that creates synergy among all the ways we reach customers, but I don’t have evidence in hand that it increases total sales especially in this current economic environment which I expect to last a while.
 
(Preview of coming attractions: What has to happen in order for Gross Domestic Product to increase? Either the population has to increase or productivity has to rise. There are no other choices. How are we doing in those two areas?)
 
Abercrombie & Fitch “…believe the improvement in sales trend during the quarter is attributable to our inventory flow getting back on track, which produced newer more trend right merchandise.”
 
“Going forward, we intend to remain highly disciplined with regard to our strategy of starting with  conservative merchandising plans, shortening lead times and increasing the percentage of our "open-to-buy" that is available to chase current trends. In addition, we have sharpened our focus on capturing current street and runway trends.”
 
“Going forward, we continue to focus on our key strategic initiatives with regard to merchandising, inventory productivity, expense and average unit cost, insight and intelligence, customer engagement and targeted closures of under-performing U.S. stores [a total of 180 from 2012 through 2015].”
 
 
CEO Mike Jeffries put it like this in the conference call: “…we’re working to become faster and we’re doing that with conservative plans, shorter lead times and more dollars open to chase, which we have said is 60 to 105 days. I think that’s affecting the fashion content of our inventory. We’re also working hard to be different by brand. We’ve invested more in brand-specific design talent. And just in terms of fashion component, we’re reacting quickly to runway and street. And I think all those things are impacting our fashion assortments.”
 
You know, that’s an awful lot like what management at PacSun, Tilly’s, and Zumiez has said recently. They aren’t talking about big sale increases. They are trying to improve their supply chain to control inventory, manage costs, and be responsive to trends. They are trying to manage all the touch points with their customers.
 
They acknowledge that how they operate has a big impact not just on their bottom line but on the quality of their market positioning. And while they don’t say, “Fast fashion is eating our lunch!” it’s clear they are responding to that.
 
Yet I’m wondering if fast fashion is really going to have legs. I don’t mean it’s going to go away, but what, exactly, is it once everybody responds by being more trend sensitive and shortening their time from concept to delivery? Doesn’t the novelty of buying inexpensive new stuff all the time wear off after a while if that’s what everybody is trying to sell you.
 
(Preview of coming attractions number two: What do my Aunt Jenny’s egg beater, a particular brand of hoodie, and a water heater have in common? Hint: They all are made in the U.S. and are meant to last a long time.)
 
With Hollister, Abercrombie & Fitch have proven that you don’t have to be core to be cool. Fun, they’ve shown us with that brand, is cool. It’s not me saying Hollister is fun; it’s their customers and that’s all that matters.
 
But meanwhile, they’ve run into some of the same issues as our industry’s other retailers and are taking many of the same steps to respond. I’ve been a big fan of improving your operational efficiency to improve profits and market positioning for a few years now. Think what that might have done for your bottom line if you’d done it when sales increases were easier to come by. But once everybody is doing it, it’s no longer an advantage, and I’m unsure of the lifespan of the trend they are responding to.