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Casual apparel retailer Abercrombie & Fitch Co. (ANF - Analyst Report) reported an outstanding financial result for the third quarter of fiscal 2012 with earnings rising over 52% year over year to 87 cents per share, handily beating the Zacks Consensus Estimate of 59 cents per share. The robust quarterly performance was primarily driven by strong top-line growth along with improved margins and lower effective tax rate.

Summary of the Quarter

Driven by robust sales performance in the international market, total sales for the company went up by 9% to $1.170 billion from $1.076 billion in the comparable prior-year period. Moreover, Abercrombie’s quarterly revenue surpasses the Zacks Consensus Estimate of $1.115 billion.

The increase in total sales reflects robust growth of 37% in international business (including direct-to-consumer sales) to $351.1 million, resulting from increased number of store counts. However, total domestic sales (including direct-to-consumer sales) were approximately flat at 818.6 million.

Overall, direct-to-consumer sales jumped 20% to $158.3 million in the quarter under review, signifying continued strength in the online business.

In the third quarter, gross profit increased 13.2% to $731.6 million while gross margin improved 240 basis points (bps) to 62.5%. The expansion in gross margin was primarily driven by reduced average unit cost and better international mix which were partially offset by unfavorable currency exchange rates and minor fall in average retail price.

Stores and distribution expenses, as a percentage of sales, improved 40 bps to 42.5% compared with 42.9% in the prior-year period on account of lower pre-opening store costs. However, marketing, general and administrative expenses escalated by $15.6 million to $123.4 million due to enhance marketing, travelling and IT expenses.

As a result of higher sales coupled with reduced input and operating expenses, operating income for the quarter increased over 40% to $112.4 million from $79.9 million recorded in the comparable quarter last year. Consequently, operating margin expanded 220 bps to 9.6% from 7.4% in the prior-year period.

Balance Sheet

Abercrombie ended the third quarter of fiscal 2012 with cash and cash equivalents of $349.7 million, marketable securities of $19.9 million and shareholders’ equity of $1.663 billion. Total long-term debt as of October 27, 2012 came in at $488.9 million.

During the quarter, the company spends approximately $104.3 million towards repurchasing 3 million shares of its common stock. The company now has total authorization to buyback 19.9 million additional shares under its share repurchase program.

Additionally, the board announced a quarterly cash dividend of 17.5 cents per share payable on December 11, 2012 to shareholders of record as of November 26, 2012.

Store Update

During the third quarter, the company opened 1 Abercrombie & Fitch store in Hong Kong and 9 Hollister stores in international locations. Abercrombie also opened a combined Abercrombie & Fitch and abercrombie kids store in Munich.

The company ended the third quarter with a total of 1,067 stores, including 295 Abercrombie & Fitch stores, 160 abercrombie kids stores, 587 Hollister Co. stores and 25 Gilly Hicks stores.

Sneak Peek into Fiscal 2012

Based on strong sales trends, Abercrombie raised its earnings guidance for fiscal 2012 to $2.85–$3.00 per share, from its earlier guidance range of $2.50–$2.75. However, the company guided towards a fall in the range of mid-single-digit in comparable-store sales for the fourth quarter of fiscal 2012.

Our Recommendation

We believe that the company’s continuous focus on expanding global operations and improving cash flows while maintaining a healthy balance sheet bode well for its future growth.

However, 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 - Analyst Report), as well as from value-priced specialty retailers like Aeropostale Inc. (ARO - Snapshot Report) and Buckle Inc. (BKE - Snapshot Report).

Consequently, we maintain our long-term Neutral recommendation on the stock, which correlates with our Zacks #3 Rank, implying short-term Hold rating on the stock for the next 1-3 months.

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.

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