Abercrombie & Fitch (ANF)

Case for Buying• Getting more lean in the U.S. • More efficient per store in net sales, closing down less efficient stores

• Favorable Leasing Opportunities:• Poor economic conditions in Europe provide means for negotiating

cheap leasing contracts. This will aid in maximizing long-term growth for the firm

• International Growth is promising• Over 70% increase in net sales per year internationally (mostly

attributed to new store sales)• Recovering economic conditions expected post recession by IMF

• High margin product• Gross margin 60% vs. competitors around 30%

• Lower or equivalent profit margin to competitors offsets this

• Push to Direct-to-Consumer (online) sales is promising• Fit the current demographic well• Fit the future demographic well

Case For Shorting• Concerns over international sales

• Primary growth in Europe (expected to be majority of sales by 2014)• Economic concerns (Greece, Spain, Italy, Ireland, U.K, etc.) • High correlation between GDP (Income) and ANF revenue• High Capital Expenditure Spending• High unemployment = low income in Europe• GDP growth expected to be lower in U.S. and key European nations from ‘12-’17 compared to prosperous

times (‘03-’08)

• Inefficient with Inventories• Inventory turnover ratio comparison to competitors

• U.S. Sales diminishing (closing a lot of stores)• Inflation likely to occur in U.S. following quantitative easing by Fed

• Inflation ->high prices which is typically good, but not for Gen Y demographic post recession• Lower income, affinity with discount items reinforced by price hike

• Issues with Current Demographic• Generation Y has come to age in a recessionary period and as a result is accustomed to discounted goods.

High brand loyalty makes it likely consumers will stick with these discounted brands moving forward (ANF is a luxury brand).• Fortune Magazine: “As well, with Gen Y’s tendency toward brand loyalty – 70% of those surveyed by Edelman Digital

claimed that they stick with brands they’ve become accustomed to – weaning them from entrenched lower-end options over the long-term may be an uphill battle for those offering luxury products and services.”

• Demographic shift from Generation Y to Generation Z• Generation Y much larger/has more spending power than generation Z • Generation Z not a great match (socially responsible orientation, less spending power, not very brand loyal)• Pricing pressure likely to result from diluted brand loyalty (leads to discounting)

Company Overview• Abercrombie & Fitch is a specialty clothing brand operating

under four unique brands: Abercrombie & Fitch, Abercrombie Kids, Hollister, and Gilly Hicks. Each brand attempts to target a different demographic of buyer to avoid cannibalization of sales from any one unit.

• ANF is considered a “casual luxury” specialty brand clothing store catering to middle income and wealthy consumers. ANF’s target consumer is aged between 7-24 with a strong focus on teenagers. Abercrombie Kids gives Abercrombie more of reach into Generation Z aiming to build brand loyalty for preteen consumers.

• As a luxury brand, ANF competes on quality over price. To move inventory and maximize inventory investment, ANF will discount items as needed and use promotional sales and marketing to move product.

Business Segments• Abercrombie & Fitch – aims to be preppy and capture the “All-

American lifestyle” as well as the “Ivy League heritage”. Aimed to be casual yet high-end apparel for teens and young adults.

• Abercrombie Kids – Similar to A&F, but targeting children.

• Hollister – Attempts to capture Southern California, beach theme style. Generally sells at a discount to A&F merchandise, so it is a lower-end casual wear brand targeted at middle class teenagers and young adults.

• Gilly Hicks – Newest brand. Sells lingerie to women. Looks to compete with brands like Victoria Secret as a hip but quality brand.

Net Sales By Brand2011 2010 2009

Net Sales (in thousands) $4,158,058 $3,468,777 $2,928,626Abercrombie & Fitch $1,665,135 $1,493,101 $1,272,287% of Total 40.05% 43.04% 43.44%Abercrombie Kids $397,904 $382,579 $343,164% of Total 9.57% 11.03% 11.72%Hollister $2,022,002 $1,552,814 $1,287,241% of Total 48.63% 44.77% 43.95%Gilly Hicks $73,017 $40,283 $25,934% of Total 1.76% 1.16% 0.89%Increase (decrease) in net sales from prior year 20% 18% -16%Abercrombie & Fitch 12% 17% -17%Abercrombie Kids 4% 11% -18%Hollister 30% 21% -15%Gilly Hicks 81% 55% 45%Increase (decrease) in comparable store sales 5% 7% -23%Abercrombie & Fitch 3% 9% -19%abercrombie 4% 5% -23%Hollister 8% 6% -27%

Geographic Distribution2011 2010 2009

United States 75% 68% 62%California 13.74% 13.18% 12.43%

Texas 9.20% 8.75% 9.16%Florida 7.82% 7.28% 6.82%

New York 5.71% 5.41% 5.23%Pennsylvania 4.65% 4.42% 4.49%

Illinois 4.23% 4.52% 4.49%New Jersey 4.23% 3.93% 3.83%

Massachusetts 3.59% 3.34% 3.08%Ohio 3.28% 3.54% 3.74%

Europe 20% 13% 8%United Kingdom 38.67% 60.00% 73.33%

Germany 20.00% 14.29% 6.67%Spain 12.00% 8.57%

Italy 9.33% 14.29% 20.00%France 6.67%

Belgium 4.00% Austria 4.00%

Sweden 2.67% Denmark 1.33% 2.86%

Ireland 1.33% Other Countries 5% 19% 30%

Canada 73.08% 88.89% 92.31%China 11.54% Japan 7.69% 11.11% 7.69%

Hong Kong 3.85% Singapore 3.85%

Geographic Dist. Analysis• Opening more stores internationally, and closing stores

domestically

• More efficient per store domestically, less efficient abroad

Store Distribution 2011 2010 2009Total # of Stores 1047 1070 1098% Change -2% -3% -Total # Europe 75 35 15% Change 114% 133% -Total # International 101 53 28% Change 91% 89% -Total # U.S. 946 1017 1070% Change -7% -5% -

Net Sales/Store 2011 2010 2009U.S. $3,286 $2,775 $2,399Europe $10,966 $12,681 $15,296Other $8,739 $11,275 $10,157

Demographics• Generation Y: Abercrombie & Fitch, Hollister, and Gilly Hicks

• Age: 17- 34 years old• Size: 71 million• Spending Power: $200 billion• Average spending of $200 million per annum on luxury items• Characteristics

• Brand loyalty – good for ANF (customer retention is cheaper than acquiring new customers)• Seeking information from the social web – Good for ANF direct-to-consumer play• Don’t like paying full price – Bad for ANF• Moving to online discount websites for purchases – Bad for ANF (premium brand)

• Generation Z: Abercrombie Kids• Age: 0- 17 years old• Size: 24 million and growing (unlikely to be as large as generation Y)• Spending Power: $43 billion• Estimated influences over $600 billion in family spending (mostly food and digital

media)• Characteristics

• Not brand loyal – VERY BAD FOR ANF (this is where they have thrived in the past)• Less responsive to “typical” advertising techniques – ANF needs to accommodate for this• Social responsibility is important – Bad for ANF (very socially irresponsible)

Industry Life Cycle• Mature industry in terms of life cycle • Revenues grows at the same pace as the economy• Company numbers stabilize• Market acceptance of product and brand• Industry consolidation (M&A activity increases)

• Translated to Capital Expenditure spending

• Why Mature? • Saturated market (high competition)• A low likelihood of product innovation• Industry value added (revenue minus costs) is expected to

underperform the economy it operates in

Determinants of Demand• Price

• Fashion Trends

• Discretionary Income

• Brand Recognition

GDP Correlation to Net Sales• A very high correlation exists between ANF’s Net Sales

(total and domestic) and U.S., UK, German, and Canadian GDP growth in both real and nominal terms.

Compared to Local Sales Total SalesComparison Metric GDP in U.S. $ Real % Nominal % Unemp

U.S. 0.99 0.92 0.93 -0.32United Kingdom 1.00 0.81 0.89 -0.29

Germany 0.91 0.67 0.50 0.46Spain 0.49 0.74 0.40 -0.22Italy 0.71 0.81 0.43 0.16

France 0.77 0.85 0.41 0.31Belgium 0.90 0.75 0.43 0.48Austria 0.91 0.76 0.48 0.41Sweden 1.00 0.83 0.88 0.04

Denmark 0.95 0.87 0.50 0.04Ireland -0.20 0.84 0.60 -0.24Canada 0.99 0.89 0.91 -0.25

Real GDP Projections by IMF• IMF projections show economic recovery over the next five to

seven years for all of the major nations ANF operates in. • *Real means adjusted for inflation (change in prices)

2012 2013 2014 2015 2016 2017Austria 0.94% 1.83% 2.21% 2.15% 2.08% 1.80%Belgium 0.01% 0.83% 1.31% 1.57% 1.75% 1.74%Denmark 0.51% 1.18% 1.82% 1.90% 1.79% 1.80%France 0.48% 1.01% 1.85% 1.90% 1.95% 2.01%Germany 0.62% 1.47% 1.26% 1.29% 1.27% 1.28%Ireland 0.52% 2.03% 2.46% 2.84% 2.87% 2.91%Italy -1.91% -0.29% 0.50% 1.00% 1.20% 1.20%Spain -1.83% 0.13% 1.16% 1.65% 1.76% 1.84%Sweden 0.85% 2.34% 3.20% 3.00% 2.40% 2.40%United Kingdom 0.82% 2.03% 2.55% 2.61% 2.70% 2.84%United States 2.11% 2.37% 2.91% 3.32% 3.51% 3.33%Canada 2.06% 2.16% 2.37% 2.42% 2.32% 2.23%

Correlation Analysis• Economic Identity: GDP = National Income

• GDP = Income -> ANF product demand is driven by discretionary income -> demand drives revenues which drives income growth

• Mature industry thus higher correlation of firm growth to economy it operates in

• International Revenue expected to be between 40% - 50% of total revenue by 2014 at current growth rates.

• Price elasticity dependent on economic conditions and consumer discretionary income. Price = key driver of demand and thus net sales

COGS Increase = Industry Problem

• Increased 6% over the last four years as a percentage of net sales

• Likely caused by increased cost of materials (cotton), and higher costs associated with overseas production. It will take time for their international expansion plan to become more efficient. Closing of less efficient stores has worked to combat this.

• Cotton prices are not a company specific risk; all firms in the industry will suffer margin pressure as these costs go up, or they will push costs to consumers. Comparing gross margin % of close competitors, this does appear to be the case.

Capital Expenditure• Capital expenditure projects for ANF almost entirely

revolve around opening of new stores. The data below shows that new stores in the U.S. have nearly ceased while internationally ANF is opening a lot of new stores. This likely explains their lack of efficiency of sales generation per store internationally.

• Other capital expenditure is likely a result of distribution centers being created for excess inventories and to support new store operations.

Capital Expenditure 2011 2010 2009U.S. 0% 15% 30%International 72% 27% 24%Direct-to-Consumer 3% 1% 0%Other 25% 31% 25%

New Stores 2012• Five Abercrombie & Fitch Stores (Hamburg, Hong Kong,

Munich, Dublin, and Amsterdam• 1 Abercrombie kids in London• 40 Hollister stores overseas• 2011: open 99, closed 71• 2010: open 40, closed 64• Cap Ex/Total Stores open and closed• 2011: $1,874• 2010: $1,547

• Cap Ex/New Store• 2011: $3,200• 2010: $4,023

Inventory Turnover• COGS/Avg. Inventory is often used because net sales are

recorded at market price where as COGS are not. • A low turnover rate may point to overstocking,

obsolescence, or deficiencies in the product line or marketing effort

• A high turnover rate may lead to inadequate supply and loss of sales. It also means a lower holding cost for the firm meaning its inventory investment is more efficient.

COGS/Avg. Inv. 2004 2005 2006 2007 2008 2009 2010 2011 2012ANF 0.60 0.60 0.39 0.36 0.35 0.32 0.32 0.39 0.43ARO 0.79 0.76 0.78 0.73 0.69 0.71 0.67 0.65 0.73AEO 7.87 7.76 7.09 6.13 5.93 6.24 5.90 5.72 5.98

Risks to Investment• Double dip recession in Europe – Greece could likely

leave the EU which could lead to high costs (over $1 trillions) and economic instability. This could translate to another recession in Europe which would largely hurt ANF’s growth strategy, especially because of their position as a luxury brand. Consumers have historically turned to lower priced items during times of economic turmoil when discretionary income is low. This will lead to further discounting as well.

• Competition• Failure to effectively implement International

Expansion plan

Net Sales Historical Data• Avg. Historical Total Revenue Growth Since 2003: 4%• Avg. Historical Total Rev. Growth Excluding ‘08-’09: 16%• Avg. Rev. Growth Internationally since ’09: 80%• Avg. Rev. Growth Direct-to-Consumer since ’09: 23%• Avg. Rev. Growth U.S. Stores since ’09: -3%• Avg. Rev. Growth U.S. Store since ’10 – 6.5%• Avg. Rev. Growth Direct-to-Consumer since ’10: 23%• Avg. Rev. Growth Direct-to-Consumer since ’10: 38%• Analysis: Net Sales growth primarily internationally and

through online sales. • Inefficient with net sales/new store internationally• Demographics suggest online avenue is a good route to pursue• Recent deal with Paypal will be a plus moving forward for

online

Net Sales Projections• IBIS World U.S. Industry growth proj. through 2017 – 2.3%• Net Sales have been driven primarily by new store sales.

This is a very costly way to generate new sales (cap ex spending and less efficient sales generation short-term). Less efficient at generating net sales per new store coupled with higher costs explains poor margin performance.

• Sales will be driven largely by discretionary income and thus the economic conditions of the nations they operate in.