American Eagle and Abercrombie: Inventory Foretells Margin Squeeze
Source: Flickr by k-ideas
Abercrombie and Fitch (ANF) considers itself a premium brand in the teen apparel space. The company believes discounting will hurt the brand. According to Chairman and Chief Executive Michael Jeffries in an earnings call with analysts, "promotions are a short-term solution with dreadful long-term effects." Abercrombie’s main competitor in the space, American Eagle Outfitters (AEO), on the other hand has aggressively discounted its products in an effort to move inventory.
I believe Jeffries has a point. In a post the last summer, I suggested Target (TGT) should raise their prices in an effort to match the perception that Target more expensive than competitor Walmart (WMT). Human psychology has us place a higher value on items that are higher priced. Jeffries is aware of this psychology thus believes discounting will erode consumers’ perception they company's tees and jeans are of higher value than their competitors. Even though any casual observer can see Abercrombie’s and American Eagle’s clothing is of the exact same quality.Generally, I would not have a problem with Abercrombie’s approach. But, if the company is going to successfully execute the no discount policy, they must do a better job with inventory management. Abercrombie seems to have flooded stores with merchandise consumers seem, for the moment at least, unwilling to buy. On the other hand, American Eagle has scaled back on inventory growth anticipating a tough holiday season. Sales and inventory growth for the most recent quarter from the same quarter a year ago are as follows: Abercrombie’s, as opposed to American Eagle’s, aggressive approach in inventory management is bound to cut into the company's margins. For the most recent quarter Abercrombie has gross margins of 66% and has averaged the same over the last five years. American Eagle on the other hand has gross margins for the most recent quarter of 41%, down from its five year average of 46%. Operating margins are another story. While Abercrombie sports some very high gross margins, their operating margins are very close to American Eagle’s. In fact Abercrombie’s cavalier attitude regarding inventory management, among other things, has chipped away at its operating margins. Abercrombie’s average operating margins for the past five years were 19% but were only 11% in its most recent quarter. Meanwhile American Eagle’s operating margins for the past five years average 18% but were 13% in the most recent quarter. Although both companies will see their margins shrink due to anemic consumer market, I would bet you will see American Eagle’s operating margins continue the trend of outpacing the margins of Abercrombie’s in the very near future. Although both stocks are down substantially over the last year, I would expect American Eagle to rebound while I am not too optimistic about Abercrombie right now. Disclosure: I and the clients of Brick Financial Management, LLC owned share of American Eagle Outfitters and Target at the time of this writing. But positions can change at any time.
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