Monday, May 4, 2009

Abercrombie Doesn't Change

In this retail environment, where consumers selectively scour for bargains, it is tempting for retailers to reduce prices in order to drive sales and reduce inventory. One company bucking this trend is Abercrombie & Fitch (ANF), whose stated number one priority through this downturn is to "protect the brands". By holding prices steady while competitors discount, management hopes Ambercrombie emerges from the recession as a superior brand that consumers are willing to pay a premium for.

Is this a good strategy? Only time will tell. In a sense, however, it is a riskier strategy, as short-term earnings are sacrificed in exchange for a future benefit of uncertain magnitude. Same-store sales are down a staggering 30% year over year, as consumer preferences have shifted towards cheaper brands. Despite the large sales drop, inventories are running some 15% above what they were at this time last year, which is undoubtedly contributing to the fact that the company has had to increase its debt load from $43 million one year ago to its current level of $157 million.

But the company appears poised to be able to weather the economic storm. ANF is still profitable despite the huge drop in sales thanks to its massive gross margins: buying apparel items manufactured in Asia and South America and selling them in North America for many times their cost has proven very fruitful for many companies which appeal to the fashion-conscious, and that's not likely to change.

There are risks to be aware of, however. If the recession deepens, ANF's cost structure could prove inflexible. While we have seen that even healthy retailers have been able to renegotiate their leases lower, the sheer magnitude of ANF's future lease obligations ($2.8 billion, larger than the company's market cap!) cannot be ignored. Nevertheless, the company does have room to reduce prices and increase short-term profits should this happen.

Disclosure: None


Nurseb911 said...

I think its a great strategy for a few reasons. #1 is that the company is making a commitment to "not compete on price" which protects their margins against their competition. There are a lot of problems that plague companies when they compete on price (see Motorola's continued problems) because once consumers get used to a price range they have difficulty paying more for the perceived identical value. The psychology of consumers is at times very odd, but if you want consumers to perceive your brand as superior you need to ensure your quality & service are above your competition as well as your price.

PlanMaestro said...

Agree Nurse, and that is particularly true for specialty retailers where the brand is the only moat. If you loose the edge, become too obicuous or just cheapen the brand the sharks are around the corner. Just ask The Gap