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Here's Why Abercrombie Offers a Balanced Risk-Reward Now

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Abercrombie & Fitch Company (ANF - Free Report) has been on the growth trajectory lately, backed by progress on its transformation initiatives, including store fleet optimization, omni-channel expansion and investment in loyalty program. Additionally, the recent strong performances in the United States and for the Abercrombie brand have been keeping the stock in investors’ good books.

These factors have collectively contributed to solid share price trend in the past three months. The stock has gained 21.4% in the past three months, outperforming the industry’s growth of 8.1%.


However, soft Hollister brand performance and disruptions in international markets are weighing on the company’s top line. Further, Abercrombie remains exposed to unfavorable foreign currency translations, which are hurting its financial performance for a while now. Also, List 3 and List 4 China tariffs are likely to hurt margins in the quarters ahead.

With these lingering headwinds, let’s see how this New Albany, OH-based apparel company will retain stock momentum.

Factors Favoring the Stock

Abercrombie reported organic sales growth in the third quarter of fiscal 2019 on strong back-to-school period and continued momentum in October despite witnessing flat revenues on a year-over-year basis. Additionally, notable gains in the United States and the Abercrombie brand primarily aided the top line and comparable sales (comps).

The Abercrombie brand benefited from positive trends in the United States on strong start to the back-to-school season, robust sell-through of products and the launch of girls’ curvy jeans collection. Further, gains in the United States for both Hollister and Abercrombie brands were driven by continued double-digit growth in digital and positive traffic trends.

Moreover, Abercrombie is making significant progress in expanding digital and omni-channel capabilities. The company’s investments in mobile, omni-channel and fulfillment have significantly aided growth of its digital business. In fact, Abercrombie is progressing well on its goal of delivering integrated digital and in-store shopping experiences. The company’s ‘purchase online, pick up in store’ (POPinS), and ‘order in-store’ capabilities are delivering strong results.

Simultaneously, the company is closely working on its global store-optimization initiative, which is a key component of its efforts to deliver operating margin expansion and reach goals for fiscal 2020. It is currently on track to deliver about 85 new experiences in fiscal 2019, whereas it delivered 67 in fiscal 2018.

Apart from omni-channel and store-optimization initiatives, Abercrombie is making significant progress on the other key transformation initiatives. Some of the latest actions include the launch of expanded payment options in the United States, a partnership with Klarna, the introduction of its China loyalty program in stores and on Tmall, the rebranding of the Abercrombie loyalty program, and offering Instagram checkout.

Factors Hindering Growth

Though the aforementioned factors make us optimistic about the stock’s potential, there are some hurdles in its growth path. The most prominent concern is the ongoing impact of tariffs and adverse currency.

Notably, the company expects top-line gains in fiscal 2019 to be offset by adverse currency impacts of $40 million of which $35 million was witnessed in the first nine months of fiscal 2019. Moreover, it expects List 3 and List 4 China tariffs to hurt cost of goods sold and gross profit by $4 million in the fourth quarter and $5 million in fiscal 2019. Gross margin for fiscal 2019 is expected to include headwinds of 40 bps from adverse currency and anticipated China tariffs.

For the fiscal fourth quarter, the company anticipates sales to include an adverse impact of $5 million from negative currency translations. Moreover, gross margin is expected to include adverse impacts of 70 bps from currency and China tariffs.

Further, soft results for the Hollister brand and international markets hurt the top line in the last reported quarter. Escalating macro headwinds in key markets led to a decline in the international business. The company is also facing uncertainties related to Brexit, which continue to hurt sales in the U.K. — its largest international market. Additionally, ongoing protests in Europe and Asia, particularly in Hong Kong, hurt comps. Also, extremely hot weather in Europe in late August and early September hurt sales for soft clothing and accessories.

Notably, Hollister has greater international presence compared with Abercrombie. Consequently, comps for the Hollister brand also reflected the impacts of the aforementioned headwinds related to the international business.

Driven by the soft trends and the aforementioned woes, the company cut the fiscal 2019 view and outlined a soft view for the fourth quarter.

Wrapping Up

The above discussion suggests that Abercrombie has balanced risk-reward. Its efforts position it for long-term growth while the headwinds may mar near-term outcomes. Further, the Zacks Rank #3 (Hold) company’s expected long-term earnings growth rate of 15.3% speaks well of its growth potential.

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