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A&F: The Numbers Behind The Model

site serif;”>Last week saw Abercrombie & Fitch open its 10th European flagship store on College Green to the delight of many onlookers who caught a glimpse of the 50 bare-chested models flown in for the occasion. This photo opportunity has become a staple of any A&F store opening, as the company maintains its exclusive athletic American image which allows itself to be marketed as a “Casual Luxury” brand. Yet, behind any marketing image there are hard financial facts which underpin the performance of a company. What are the key drivers behind the A&F model? Why Dublin? Why now?

Since going public at the end of 1996, A&F has kept a high public profile through its sexually-orientated marketing and numerous law-suits. Initially the brand was portrayed as a “near-luxury” due to the high quality of materials used to manufacture its goods. With the opening of its flagship Fifth Avenue store in 2005, the firm decided it had reached the level of a luxury brand – a trait which has been the bedrock of its international expansion since. Looking at a chart of the company’s share price, we can see that the stock began to rise significantly on the back of the Fifth Avenue opening, and self-proclamation as “Casual Luxury”. A&F peaked at a price of $82.65 in mid 2007, with a collapse in share price one year later to under $20. Same store sales plummeted by 30%, as the firm continued to charge high prices while competitors began to successfully mimic its styles and marketing practices, leading to a sharp decline in market value.

Expansion out of North America began in 2007 when A&F opened its first international flagship store on London’s elite Saville Row. However, further expansion did not come until 2009 when the firm opened up in Milan and Tokyo. This was reflected in the share price with an upward trend which continued until late 2011 as more and more international stores opened up. While the Abercrombie & Fitch brand has less than 20 stores outside North America, the cheaper Hollister brand has 28 in the UK alone. The Hollister Co. arm made up almost 49% of parent Abercrombie & Fitch Co.’s revenue in 2012. Over the three previous years to end of FY 2012, international sales for the group grew by 58.34% while US sales fell by 1.17%. This increasing international revenue pulled up Earnings per Share (EPS) over the period, which fueled the upward movement in the stock price.

In the second half of last year, the company announced a massive drop off in comparable store sales in the domestic US market. Management reacted by increasing mark-downs and promotional offers which squeezed the net revenue per item sold. Wall Street did not look favourably on these actions, reducing its expectations of future profitability which led to a sharp fall in the ANF listing. 2012 has continued to be a year full of challenges. The decline in European demand and a generally weak international consumer sentiment led to a Year-on-Year 29% drop in international same-store sales, as reported in the August quarterly earnings report.

The initial outperformance of A&F’s global expansion has meant that the recent declines still allow this venture outside of North America to be very profitable. Yet, A&F HQ has acknowledged the limitations to this international growth, which is being reflected in the sales figures. No new flagship store openings have been announced for the A&F brand, while the recent Dublin and Seoul stores faced a great reduction in scope. 40 more Hollister stores are due to open outside the USA next year, with only 25 more in 2014. In essence, A&F recognize the benefits from an international operation but have learned that less aggressive opening schedules and less cannibalization (eating into its own regional success) is the way forward. Coupled with our domestic economic woes, this would explain the delay in opening the Dublin store and also why the store is much smaller than initially anticipated.

The future economic success of Abercrombie & Fitch Co. appears to be in the hands of management, who are overseeing a company with an operating margin of 7.9%, compared to 12.5% for American Eagle and 15.8% for Ralph Lauren. Given the economic climate, A&F is currently performing well in generating sales revenue, while underperforming in cost management. Analysts attribute this to “business model-breaking” levels of inventory in the firm and highlight a lagging fashion sense – most notably in the coloured jeans arena – as a key weakness. However, many on the Street believe that A&F will be able to increase its operating margin to at least 10% if not in line with American Eagle’s. This means that the stock is currently undervalued at $32.85, with a consensus target of $38.07,in the short term. Some analyst reports project a price of $50-60 within a few years.

§With third quarter results due on the 14th of this month, 21 analysts surveyed by Bloomberg recommend holding positions, 11 recommend buying ANF, with 3 selling the stock. It would appear more worthwhile splashing out €200 as an investment in the A&F Model, rather than €200 in-store to look like one.

By Eoin Callaghan

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