Did the Market Overhype Abercrombie & Fitch?

Did the Market Overhype Abercrombie & Fitch?

Friday, Jan. 10, was a good day for shareholders of Abercrombie & Fitch as shares jumped nearly 12%. The reason was based on an announcement that its sales have been better than expected so far this quarter. However, is this improvement in the company's top line really all that it's cracked up to be?

Preliminary results look OK but are far from great!
Looking at the company's update, we can conclude two things. First, its sales are turning out to be better than expected. Second, its results are still quite terrible. Appealing to optimism, management has elected to emphasize the first point over the second.

For the first nine weeks of the company's fourth quarter, management saw total comparable sales decline by 6%. If this trend does not change, then revenue will likely come in somewhere around $1.38 billion compared to the $1.47 billion that it saw in the same quarter a year earlier. But, it's important to keep in mind that the company's results have been different across the various parts of its business.

For instance, comparable-store sales in the United States fell by only 4%. While this isn't something to be happy about, the company's U.S. segment is, the largest of the three. In 2012, sales in this segment comprised 58% of consolidated sales. The downside though is that it only made up 41.1% of operating income that year.

Abroad, Abercrombie & Fitch hasn't been so lucky. The company's International sales fell 10% on a comparable store basis. This could be particularly damaging as this segment made up 26.5% of total revenue in 2012, but 33.3% of its operating income.

Probably the only upside for the quarter has been Abercrombie & Fitch's direct-to-consumer segment (aka its online sales). According to management, this operation saw an increase in comparable sales of 25% compared to the same period a year earlier. This is tremendous for shareholders and is likely the main reason why shares jumped so much on Friday.

Over the past three years, the company's online business has been its smallest, but also its fastest-growing. From an operating margin perspective, the company blows away its peers. While the operating margin for Abercrombie & Fitch's U.S. segment sat at 16.5% in 2012, its operating margin internationally was a hefty 29.4%, and its direct-to-consumer segment was a jaw-dropping 38.5%. This disparity was primarily due to the company's ability to forgo the cost of running retail locations.

How does Abercrombie & Fitch stack up against American Eagle?
The past four years have been very kind to Abercrombie & Fitch. Over this timeframe, the company's sales have risen 54% from $2.9 billion to $4.5 billion, while its net income rose from $0.3 million to $237 million. In comparison, rivals like American Eagle Outfitters and Aeropostale have struggled.

American Eagle, for instance, has seen its revenue rise only 18.2% from $2.94 billion to $3.48 billion. According to the company's most recent annual report, the jump in revenue is primarily attributable to increased brand recognition. In 2013 alone, the company saw its AEO Brand sales rise 7%. This was in conjunction with a 25% increase in its AEO Direct operations, which represents the company's online sales.

Over this timeframe, the company saw its net income jump 37.3% from $169 million to $232.1 million. While this is an attractive increase, it pales in comparison to Abercrombie & Fitch's rise. The disparity between revenue growth and net income growth was primarily attributable to a decrease in the company's costs. From 2012 through 2013, for instance, management reported that the company's cost of goods sold fell from 63.3% of sales to 60%. Costs also fell from 2011 through 2012, but this was primarily due to lower selling, general and administrative expenses as a percentage of sales.

How about that Aeropostale?
Over the same timeframe as American Eagle and Abercrombie & Fitch, Aeropostale's revenue has risen by 7%. But the company was only able to maintain sales growth by lowering profitability, as demonstrated by its 84.8% fall in net income.

The company's net income fell, from $229.5 million to $34.9 million, because of two controllables. The primary driver behind its lower net income was the company's cost of goods sold, which rose 29.9%, far outpacing its revenue growth. Meanwhile, its selling, general, and administrative expenses rose 14.1%.

Foolish takeaway
Historically speaking, the performance at Abercrombie & Fitch has been amazing. However, in a time when several retailers are on the decline, it is beginning to show signs of fatigue. In its most recent quarter, the company's sales declined 11.7%, while it swung to a loss of $15.6 million.

Moving forward, management will likely have a hard time maintaining profitability, especially as the company's two largest segments are crashing. On the upside, its online operations on hot. If management can effectively grow this brand, then sales may drop but margins will likely rise. If, on the other hand, management falters, then it's likely the entire company will go down the drain.

The article Did the Market Overhype Abercrombie & Fitch? originally appeared on Fool.com.

Daniel Jones has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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Originally published