Will Abercrombie & Fitch Pass the Inflation Test?

Apparel retailer Abercrombie & Fitch (NYS: ANF) recently posted better-than-expected second-quarter earnings. However, the company's stock, which had more than doubled in the past year, sold off after the announcement of the earnings. Confused?

A look at the numbers
Net income for the quarter rose to $32 million, a whopping 64% increase from a year ago. The company reported earnings per share of $0.35, compared to Street estimates of $0.30. The international business for A&F grew revenues by 74%.

Nevertheless, there is a fear of inflation looming over the company. Inflation has already pulled down the gross margin, to 63.6% from 65.1% a year ago. Management feels the pinch of costs and expects macroeconomic uncertainties and falling consumer confidence to compound the pain of cost pressures, resulting in worse margins in the second half of the year. A&F is offsetting the problem by increasing prices.

Rising raw materials costs have already started threatening other industry players such as Urban Outfitters (NAS: URBN) , which saw a fall of 18% in operating profits in the latest quarter, and Gap (NYS: GPS) , which reported a dip in gross margins to 36.9% from 39.6% a year ago. But unlike Gap's 3% decline in same-store sales, A&F saw a growth of 9% in same-store sales, which shows the relative strength of the company even in a troubled environment.

Keeping an eye on its long-term strategy, the company plans to open five new flagship stores along with 40 international mall-based Hollister stores. Though it requires capital expenditures of $350 million, the company has a strong balance sheet. But the company is also letting 60 to 65 domestic stores close as their leases expire.

The Foolish bottom line
Though this company has solid fundamentals, I suspect it might be a victim to inflation in the coming months. We don't know how consumers will react to increased product prices. However, with strong sales momentum, this apparel seller looks better than its peers. Fools should take note.

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At the time this article was published Navjot Kaur does not own any shares in the companies mentioned above. The Motley Fool owns shares of Gap. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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