Why Abercrombie & Fitch’s Store Closings Spell Big Trouble

Already struggling with sluggish sales and low gross margin, the company will face significant challenges from store closures.

This article was originally written by Lawrence Rothman of The Motley Fool

Recently, Abercrombie & Fitch (NYSE:ANF) decided to close all of its stores outside the Asia-Pacific (APAC) region for approximately two weeks in an effort to slow the spread of the coronavirus. Either by choice or by government mandate, other retailers and restaurants have taken similar steps, shutting their doors to consumers to protect the public’s health.

The consumer-discretionary sector is facing lower sales and profitability for the foreseeable future. While investors can hope the economy brushes this disruption off relatively quickly, allowing people to return to their jobs and routines, including their usual shopping habits, we are in uncharted territory.

For Abercrombie & Fitch, which was already grappling with several challenges, the store closures will only make things even tougher.

Margin pressure

The company’s gross margin was already shrinking, largely due to pricing pressure. Its fiscal fourth-quarter (ended Feb. 1, 2020) same-store sales increased just 1%, but its gross margin contracted to 58.2% from 59.1% in the year-ago period.

Hence the company was not able to drive meaningful comps growth despite markdowns. Higher expenses caused Abercrombie’s operating income to fall 6% year over year to $122.3 million.

Management previously laid out three phases to drive long-term growth. The first phase, which lasted from fiscal 2015 through fiscal 2017, involved “stabilizing while transforming.” The company has moved on to the next step: “growing while transforming” — this phase is supposed to run through fiscal 2020. The last phase, “accelerating growth,” would begin in fiscal 2021 and run indefinitely.

These challenging results came in the middle of management’s second phase, in which its goals include accelerating sales and doubling fiscal 2017’s operating margin by the end of fiscal 2020. But instead of making progress toward these goals, the company took a step backward last year with only 1% comps growth (down from 3% in fiscal 2018) and a contracting operating (and gross) margin.

Where do things go from here?

On a positive note, the company ended fiscal 2019 with less inventory than a year ago. This is always good for a retailer since that means it is not carrying over stale merchandise from the prior period.

But as management closes stores in North America, Europe, the Middle East, and Africa, which together generated more than 90% of its top line, the company will have to turn to its online business. However, I don’t see how it will make up so much revenue through just one channel. Add to that the global economic uncertainty as people stay home and face financial hardship, and the company is sure to end up with a large inventory stockpile.

This means that when consumers finally look beyond the coronavirus, Abercrombie will have to discount heavily to clear its shelves. Such an effort also takes time and prevents the company from offering fresh, new products.

Management withdrew its fiscal 2020 first-quarter and full-year guidance less than two weeks after providing it. At the time, the company expected comps to experience a low-single-digit decline for the year (including a 200 basis point hit from the effects of COVID-19). It also expected a further reduction in its gross margin.

When management can’t confidently predict what is going to happen, what chance does an average investor stand? For my money, given the company’s existing problems before the coronavirus became a pandemic and the company shut down stores, these latest developments spell serious trouble for Abercrombie & Fitch. While you’re staying away from the stores, you should avoid the stock, too.

MyWallSt operates a full disclosure policy. MyWallSt staff currently hold no positions in companies mentioned above. Read our full disclosure policy here.

Lawrence Rothman, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.