(ANF) Abercrombie & Fitch Beats on Earnings

Casual apparel retailer Abercrombie & Fitch Co. (ANF) reported earnings of 19 cents per share for the second quarter of fiscal 2012, beating the Zacks Consensus Estimate of 17 cents per share.

However, the quarterly earnings dipped substantially from the year-ago earnings of 35 cents per share due to higher average unit costs along with increased operating expenses and a higher tax rate.

Revenue

Driven by robust sales performance in the international market, total sales for the company went up by 4% to $951.4 million from $916.8 million in the comparable prior-year period. However, Abercrombie’s quarterly revenue missed the Zacks Consensus Estimate of $955 million.

The increase in total sales reflected robust growth of 31% in international business (including direct-to-consumer sales) to $303.4 million, partially offset by a decline of 5% in domestic sales (including direct-to-consumer sales) to $648.0 million.

Overall, direct-to-consumer sales jumped 25% to $127.7 million in the quarter under review, signifying continued strength in the online business. During the quarter, comparable store sales fell 10% compared with the year-ago period, reflecting a decline of 5% and 26% in domestic stores and international stores, respectively.

Summary of the Quarter

In the second quarter, gross profit inched up 1.9% to $594.4 million while gross margin contracted 110 basis points to 62.5%. The contraction in gross margin was due to a substantial rise in the average unit cost and unfavorable currency exchange rates.

Stores and distribution expenses, as a percentage of sales, grew to 48.1% from 46.4% in the prior-year period on account of negative comparable-store sales. Moreover, marketing, general and administrative expenses escalated by $1.3 million to $113.3 million due to enhanced marketing, traveling and IT expenses.

Operating income for the quarter declined substantially to $26.9 million from $47.2 million recorded in the comparable quarter last year. This resulted in operating margins dipping from 5.1% in the prior-year period to 2.8%.

Balance Sheet

Abercrombie ended the second quarter of fiscal 2012 with cash and cash equivalents of $312.2 million, marketable securities of $20.1 million and shareholders’ equity of $1,695.8 million. Long-term debt as of July 28, 2012 came in at $62.8 million.

During the quarter, the company did not repurchase shares of its common stock. Further, the Board of Directors added an authorization of 10 million shares to the existing share repurchase program. The company now has total authorization to buyback 22.9 million additional shares under its share repurchase program.

Additionally, the board announced a quarterly cash dividend of 1.75 cents per share payable on September 11, 2012 to shareholders of record as of August 27, 2012.

Store Update

During the second quarter, the company opened 7 Hollister and 3 Gilly Hicks stores in international locations. Abercrombie also opened a combined Hollister Gilly Hicks store in London.

The company ended the second quarter with a total of 1,055 stores, including 293 Abercrombie & Fitch stores, 159 abercrombie kids stores, 578 Hollister Co. stores and 25 Gilly Hicks stores. Following the quarter-end, the company has put up one more Abercrombie & Fitch store in Hong Kong.

Sneak Peek into Fiscal 2012

Based on weak sales trends along with strong domestic currency and increased tax rates, Abercrombie has trimmed its earnings guidance for fiscal 2012 to $2.50–$2.75 per share, from its earlier guidance range of $3.50–$3.75. Currently the Zacks Consensus Estimate stands at $2.54 per share.

In addition, the company guided towards a fall of 10% in comparable-store sales for the second half of fiscal 2012. However, it expects a significant recovery in its gross margin contraction rate in fiscal 2012 compared with fiscal 2011.

Due to macro-economic headwinds, Abercrombie revised its strategic plans for the fiscal 2012. Management is aiming to open about 30 Hollister stores in international locations in fiscal 2012, many fewer than their earlier target of 40 stores.

Further, the company intends to hold its store openings commitments in domestic as well as international markets. Abercrombie has slashed its fiscal 2012 capital expenditure by $40 million to $360 million.

Our Recommendation

Abercrombie is one of the leading specialty retailers of premium casual apparels in the U.S. The company has a strong portfolio of well-established brands, each of which is focused on the unique characteristics and rapidly changing preferences of its target customers.

In the face of economic challenges, where teenagers have become less active shoppers, Abercrombie has shifted its focus toward closing down its underperforming U.S. chain stores and accelerating growth at its Abercrombie Kids and Hollister store concepts. Moreover, the company is concentrating on increasing its presence in international markets in order to drive the top-line growth.

Abercrombie operates in a highly fragmented market and competes with national as well as regional players, which may take a toll on its performance. Furthermore, Abercrombie is facing increasing competition from larger retailers, such as Gap Inc. (GPS), as well as from value-priced specialty retailers like Aeropostale Inc. (ARO) and Buckle Inc. (BKE).

Based on lower guidance for the fiscal 2012, Abercrombie carries a Zacks #5 Rank, implying a short-term Strong Sell rating for the next 1-3 months. However, we maintain our long-term Neutral recommendation on the stock.

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