Abercrombie’s Earnings Plunge on Lower Chain Store Traffic

Retailer’s net sales fell 6% to $821.7 million versus $878.5 million in the year-ago period

a1Global specialty retailer Abercrombie & Fitch Co. (NYSE: ANF) announced its Q3 FY16 financial results on November 18th, 2016.

The New Albany, Ohio-based Company, through its subsidiaries, operates as a specialty retailer of casual apparel for men, women and kids with an active, youthful lifestyle under its Abercrombie & Fitch, abercrombie kids, and Hollister Co. brand names. The Company sells its products through its stores and direct-to-consumer sales as well as through its e-commerce websites at www.abercrombie.com, www.abercrombiekids.com and www.hollisterco.com. Read more about Abercrombie & Fitch’s financial results below.

Q3 FY16 financial highlights

During Q3 FY16, Abercrombie & Fitch’s net sales fell 6% to $821.7 million versus $878.5 million in the year-ago period; sales have fallen for 15 straight quarters. By brand, net sales for Q3 FY16 fell 13% to $358.3 million for Abercrombie and 1% to $463.5 million for Hollister over the same period last year. By geography, net sales for Q3 FY16 fell 7% to $531.4 million in the U.S. and decreased 5% to $290.3 million in international markets over the year-ago period.

As with The Gap Inc. (NYSE: GPS), comparable sales fell 6% during Q3 FY16. On the brighter side, direct-to-consumer and omni-channel sales grew to about 23% of net sales in Q3 FY16, compared to 21% in the year-ago period. Sales mix by brand and geography are shown below.

Source: Abercrombie & Fitch
Source: Abercrombie & Fitch

The Q3 FY16 results show that Abercrombie and specialty retailers at large are strugglinga3 with a tourism slowdown owing to their heavy reliance on large, flagship locations in major cities to drive sales. Abercrombie’s poor performance is attributed to the dearth of spending by travelers, who have been discouraged from shopping due to the strengthening dollar and global economic uncertainty. As a consequence, flagship and tourist locations continued to account for the vast majority of the comparable sales decline during the reporting quarter; the Company expects those stores to continue to weigh on the business for the rest of the year.

Additionally, apparel retailers in general are predicted to have another tough holiday season as fewer shoppers visit malls and continue to spend less on clothes. Abercrombie has been closing stores and investing more for online businesses to cope with rapidly changing consumer tastes and stiff competition from Amazon.com Inc. (NASDAQ: AMZN) and fast-fashion retailers such as H&M and Inditex’s Zara. Adding to its woes, the unusually warm weather has also hurt sales, because of which Abercrombie will have to deal with excess inventory as it adds new items for the holiday shopping season. This in turn would mean more discounts and promotions at retailers, and a further hit to margins.

During Q3 FY16, gross profit rate declined to 62.2% from 63.7% in the year-ago period. Excluding certain items last year, the gross profit rate decreased 60 basis points on a constant currency basis, primarily due to lower average unit retail, partially offset by lower average unit cost. Stores and distribution expenses fell to $386.6 million from $392.9 million last year. Excluding certain items last year, stores and distribution expense decreased $5.8 million, primarily due to the realization of savings on lower sales and expense reduction efforts, partially offset by higher direct-to-consumer expense.

The company’s marketing, general, and administrative expenses for Q3 FY16 also declined to $105.3 million from $117.7 million last year. Excluding certain items, adjusted non-GAAP marketing, general, and administrative expense decreased $6.4 million, primarily due to expense reduction efforts, partially offset by higher marketing expenses. As a result, operating income plunged to $19.6 million compared to $41.0 million in the year-ago period. Consequently, Q3 FY16 net income nosedived to $7.9 million, or $0.12 per share, from $41.89 million, or $0.60 per share, a year earlier. Excluding certain items, Abercrombie earned $0.02 per share, well below analysts’ average estimates of $0.21 per share.

Other highlights

Cash position: Abercrombie ended Q3 FY16 with cash and cash equivalents of $469.7 million, and gross borrowings under the company’s term loan agreement of $293.3 million compared to $405.6 million in cash and cash equivalents and $297.0 million in borrowings last year.

Inventory: Abercrombie ended Q3 FY16 with $516.1 million in inventory, a decrease of 14% versus last year.

Store update: As of the end of Q3 FY16, Abercrombie had 930 stores, of which 745 were in the U.S., 18 in Canada, 117 in Europe, and 50 in Rest of the World.

a4Abercrombie will be closing its A&F flagship store in Seoul in January 2017. In addition, subsequent to the end of Q3 FY16, the company exercised a lease kick-out option for its A&F flagship store in Hong Kong. As a result of this decision, Abercrombie expects to incur a lease termination charge of approximately $16 million during Q4 FY16.

In addition to the 13 stores opened year-to-date, including five outlet stores, Abercrombie expects to open seven new stores in Q4 FY16, including five in China and two in the U.S. The company also anticipates closing approximately 35 stores in the U.S. in Q4 FY16 through natural lease expirations, in addition to the 15 stores closed year-to-date.

Dividend: Abercrombie announced on November 16th, 2016, that its Board of Directors declared a quarterly cash dividend of $0.20 per share on the Class A Common Stock payable on December 12th, 2016, to stockholders of record at the close of business on December 2nd, 2016.

Guidance for Q4 FY16 and full year FY16

For Q4 FY16, Abercrombie expects comparable sales to be challenging, but modestly improved from Q3 FY16. The company also projects continued adverse impact from foreign currency on sales and operating income. Gross margins are forecasted to decline slightly to last year’s adjusted non-GAAP rate of 60.7%, driven by lower average unit retail, but partially offset by lower average unit cost. Operating expenses, including a lease termination charge of approximately $16 million, are predicted to rise by about 1% from last year’s adjusted non-GAAP operating expense of $554 million, with the lease termination charge partially offset by savings from lower sales and expense reduction efforts. Net income is forecasted to be approximately $1 million for the quarter. Capital expenditures are forecasted to be about $140 million for the full year FY16.

For FY16, Abercrombie expects to face headwinds in comparable sales through H2 FY16, with a disproportionate effect from flagship and tourist locations. Moreover, Abercrombie expects net income attributed to non-controlling interests of approximately $5 million. The company expects capital expenditures to be at the low end of the range of $150 million to $175 million for the full year FY16. Overall, Abercrombie expects headwinds to persist for domestic teen retailers, including heightened competition and a weak fashion cycle.

Stock Performance

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Abercrombie’s stock ended the day at $14.76, climbing 1.10% from its previous closing price of $14.60, at the close on Monday, November 21st, 2016, having vacillated between an intraday high of $14.98 and a low of $14.22 during the session. The stock’s trading volume was at 7,461,817 for the day. The Company’s market cap was at $1.16 billion as of Monday’s close.

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