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Abercrombie Narrows Q1 Loss, But Tariff Hike Threatens Q2 Gross Profit Rate

Abercrombie & Fitch Co. (A&F) narrowed its first-quarter loss, but also saw a slower start to the second quarter. It also elected to shut some flagships as it shifts away from large format stores, and the company provided a second-quarter gross profit forecast that’s expecting a decrease based solely on the increase in tariffs that just went into effect.

In a Nutshell: Chief executive officer Fran Horowitz noted that the company achieved its seventh consecutive quarter of positive comparable sales fueled by continued strength at Hollister and a “return to positive comps at Abercrombie.”

The company decided to close more of its larger format stores. In the quarter, the A&F flagship store in Copenhagen, Denmark was closed. It will be followed by the shuttering of the Hollister flagship store in the SoHo neighborhood in Manhattan in the second quarter.  Two other overseas A&F flagship stores will close later on: the one in Milan will close by the end of the current fiscal year, and the one in Fukuoka, Japan will close its doors in the back half of fiscal 2020. Abercrombie said the four locations combined represented less than 1 percent of total net sales in fiscal 2018. Since the closure of the A&F flagship on Pedder Street in Hong Kong in the first quarter of fiscal 2017, the company has been optimizing its store network. In addition to closing some stores and updating others, it also has been focused more on smaller, omnichannel-focused stores that provide elevated brand experiences.

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Shares of Abercrombie & Fitch began falling in pre-market trading after the company posted earnings results and continued through the morning after the markets opened for Wednesday’s trading session. Abercrombie shares were down in the range of 24.8 percent to $18.80 shortly before noon time. While the company did better than Wall Street expected when looking at just the improved loss per diluted share and on revenues posted, it wasn’t enough for investors. They instead focused on slowing comparable sales, particularly at Hollister, and weaker guidance for the second quarter.

In a telephone interview, Horowitz said, “Hollister had a good quarter and we continue to be excited about its 10th consecutive quarter of positive comps. It has a strong U.S. business and an improved European business. The one place we missed was Asia. It’s a small part of the overall business, but it drove down comps.”

As for its core Abercrombie brand, the CEO said comps went from negative to positive in the fourth and first quarters, respectively. And she cited the agility of the team which, using the firm’s supply chain resources, was able to identify trends and adjust orders to right its dress category to recover first quarter sales from the negative trend in the fourth quarter.

Between the two brands, Horowitz said Europe has been challenging for the Abercrombie brand, while Asia was the biggest challenge for Hollister.

More importantly, Horowitz was optimistic about selling opportunities in the second half. “We saw out of the gate for the first few weeks in May sales that were softer than anticipated. We have 80 percent of the quarter ahead of us, as we enter our prime selling season kicking off back-to-school sales. The customer is responding to newness and we are staying close to the customer.”

She also spoke of opportunities to come, noting the planned integrated marketing campaigns that have done well for the brands, as well as a size and market optimization initiative that the company just “kicked off in the second quarter. We have personalization in transformation and there are lots of things brewing as we head to the back half.”

Net Sales: Net sales for the quarter ended May 4 rose 0.4 percent to $733.8 million, from $730.9 million. Consolidated comparable sales rose 1 percent on top of the 5 percent gain a year ago.

By brand, Hollister comps rose 2 percent in the quarter, with Abercrombie up 1 percent. By region, sales in the U.S. rose 4 percent, while international sales fell 4 percent.

The company also upped its capital expenditures in the quarter to $43.9 million from $23.7 million last year. It remains on track to deliver about 85 updated experiences either through new stores, remodels and right-sizing initiatives for the current fiscal year.

According to the CEO regarding overall fashion trends, shorts have been strong sellers, while women have been interested in waist and tie details in softer fabrics. The female customer also has shown strong response in the first quarter to rompers, dresses and jumpsuits, all part of the dress category at Abercrombie. In denim, women have responded to higher rises and hem treatments. Men have shown interest in pull-on shorts.

“There are lots of things still happening in denim. Both he and she are still buying destroyed denim, and that’s a nice trend as we head into back-to-school,” the CEO said.

Earnings: The company narrowed its net loss to $19.2 million, or 29 cents a diluted share, from a net loss of $42.5 million, or 62 cents, a year ago. The company said the loss per diluted share was adversely impacted in part by year-over-year changes in foreign currency exchange rates.

Wall Street was expecting a loss of 44 cents on revenues of $733.2 million.

For the second quarter, the company is expecting net sales to be flat to up 2 percent, with comparable sales estimated to be flat, on top of the 3 percent gain a year ago. The company also projected gross profit rate down 100 basis points versus 60.2 percent last year, presuming that only the current tariffs are in place.

For fiscal 2019, the company projected net sales to rise between 2 to 4 percent, driven in part by positive comparable sales and net new store contribution. Comparable sales were guided up low-single digits, on top of the 3 percent gain a year ago. Gross profit rate was guided to rise slightly from the 60.2 percent from fiscal 2018. The projection also presumes just the current tariffs in place.

Horowitz said in the telephone interview that the current tariffs were baked into the outlook, but not the potential next tranche of 25 percent on $300 billion in goods that include apparel because that’s still speculative for the moment. She also noted that the company had made a “concerted effort to migrate out of China and migrate into other countries.” She noted that a few years ago about 40 percent of goods were China-sourced into the U.S. That percentage dropped to 25 percent last year and for the current fiscal year 2019, the expectation is that it will drop to “under 20 percent,” Horowitz said.

But one potential hiccup that was left unsaid, because it’s still speculative, is the potential impact on the bottom line if the next tranche of tariffs actually goes into effect. Economists have been projecting that any increase, if approved, would likely go into effect around the end of August and the Labor Day weekend, which would impact the back-to-school selling season this fall and beyond.

CEO’s Take: Horowitz said, “We are focused on our transformation initiatives, with global store network optimization a key priority. We continue to believe in stores and are committed to delivering intimate, omnichannel brand experiences that closely align with our customers’ needs.” She emphasized that the company is “on track” to achieve its fiscal 2019 outlook and is continuing to lay the foundation to achieve its fiscal 2020 targets.