Abercrombie & Fitch (ANF): more than meets the eye

A GARP company or a falling consumer-discretionary knife?

Abercrombie & Fitch (ANF) is a fantastic example of excessive market optimism immediately followed by pessimism. Its valuation went from an EV/S of 0.2x in July 2022, to 2x (a 1,000% increase) in May 2024, and then down 50%+ to 0.7x now. At some point in that rollercoaster lies the fair value of the company.

Today, pessimism is prevalent, on the read that Abercrombie just ‘got lucky’ and surfed a fashion wave that is now receding. In that read, Abercrombie is simply another consumer discretionary boom and bust story.

Despite the obvious challenges in using multiples for operationally levered consumer discretionary companies, it is striking how a company growing comparables at 14% can trade for 7x NTM earnings.

This discrepancy led me to a small dive into Abercrombie’s story, the result of which is this article. In it, I quickly go over the traditional ‘turnaround story’ that was repeated at nauseam when the stock was booming, and then into the company’s reformed business model. I analyze social media and alternative data on competition with American and foreign apparel retailers. Finally, a few simple ‘scenarios’ to understand what could be priced in today’s share price.

My conclusions are not ‘conclusive’. Because of fashion and macro risk, Abercrombie will always be a risky play. However, I think I have gathered some evidence (that I haven’t seen compiled elsewhere) to show that Abercrombie has significantly changed its brand identity with consumers, separating itself from other large American retailers (AEO, GAP, URBN), and getting much closer to the best fast-fashion operators as a go-to place for better/best quality apparel.

If that is correct, and with a moderately neutral macroeconomy, Abercrombie should have space to continue growing profitably. In that case, the name is undervalued at 7x NTM earnings.

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. I own shares of Abercrombie & Fitch Co. (ANF).

Index

• Abercrombie’s history before 2014

• Business model transformation: from manufacturer-retailing mix to pure-retailing

• Differentiation in the retail model via quality

• Two simple scenario models

Other Consumer Discretionary articles

Footwear primer (and US companies)

Apparel Series IV: Company reviews

Apparel III: Apparel Manufacturers and Fashion

Apparel Series II: Retailer Pitfalls

Executive summary

Model change to ‘fast’-fashion: Abercrombie’s core transformation since the mid-2010s was a move from an identity-heavy apparel manufacturer with retail operations, towards a pure fashion retailer model. This change affects several areas of the business:

• Positioning via identity markers like logos, models, and design was replaced by positioning via value.

• Design moved from trend-setter, identitarian to trend-follower or ‘always on trend’ basics. The company’s products are no longer very different from those of competitors.

• Merchandising and supply chains were improved, allowing higher inventory velocity and more SKUs. Abercrombie is not a ‘fast’ retailer but can introduce variety on the collection without adding too much inventory.

• The cost structure was transformed and moved to a more variable-weighted model: more spent on marketing and shipping, and less on fixed rent and payroll.

Reduction in fashion risk: A key risk for any identity-heavy apparel brand is a change in fashion trends. This is what destroyed Abercrombie in the 2010s and a lot of people believe it will happen away. However, Abercrombie’s model is now different, reducing fashion risk going forward.

New positioning challenges: The lower fashion risk from being more average comes at the expense of lack of clear differentiation with competitors. In the pure-retailing space, differentiation comes from positioning queues in style, quality, and pricing. Abercrombie (the brand) is strong in a position of better/best stylish basics, whereas Hollister fights in the more competitive teenager good/better space.

Recognition from KOLs: Abercrombie’s customer success is evident in revenue metrics, but also in social media. Both Abercrombie and Hollister are winning in search trends against competitors. Fashion Youtubers and fashion forums on Reddit recognize Abercrombie’s (brand) position as a quality basics apparel retailer. None of the American competitors (Gap, Urban Outfitters, American Eagle) is remotely as mentioned in the same forums. These companies are also losing against Abercrombie and Hollister in search trends and on Tiktok.

Valuation, operating leverage, scenarios, and macro: Today Abercrombie trades at an optically low multiple of 7x NTM earnings, while growing comparables at 14% YoY.

However, operating leverage makes earnings multiples a bad friend in retailing: a small change in sales or gross margins can make earnings fluctuate a lot. In the case of Abercrombie that risk comes from gross margins and the need to potentially become more promotional in a season-bust or in a macroeconomic cold period. This is simply part of retail’s risk for any company.

Still, doing some simple scenario models, I find that the breakeven return for Abercrombie’s stock at $85 is flat growth and 8% operating margins, versus 14% growth and 15% operating margins today. I think this is where the opportunity lies.

Abercrombie’s history before 2014

Abercrombie is an old company, founded in 1892. At the time it sold premium hunting apparel and articles (that’s where the historic moose logo comes from). Fast forward a century, and the company is acquired by Limited Brands, a legendary brand house responsible for successes like Victoria’s Secret, Express, and Bath Body & Beyond. In 1992, Michael Jeffries became Abercrombie’s President. His 22-year tenure into 2014 is one of the biggest success histories in branding. Abercrombie moved from less than $100 million in revenues in 1992 to $4.5 billion in 2014.

In 2000, Abercrombie added Hollister as a younger brand. The two brands were very similar in their key identitarian aspects and represented a lot of 1990s/2000s mainstream culture: consumerism, exclusivity as a value, admiration for white hegemonic bodies, large logos. This was a driver of massive success and by the early 2000s, Abercrombie and Hollister were both among the preferred brands among teenagers. This is the image of Abercrombie and Hollister that most people have on their minds, especially millennials: t-shirts and polos with massive names and logos that were an instant ticket to upper-middle-class status in high school.

Unfortunately, Abercrombie’s assets proved its liabilities. Abercrombie was an apparel manufacturer back then, and all that made its identity so strong also made it incredibly weak when the fashion trend changed.

The fashion trend did not just recede but eventually shifted 180 degrees. The mainstream taste started to value minimalistic branding, no logos, body positivity, rejection of sexism and racism, and muted colors. Being a strong representative of the previous period, Abercrombie was strongly rejected in this cultural shift. All of its brand identity became dead weight, and eventually, the company was the center of sexism scandals, with Jeffries indicted for sexual trafficking.

Business model transformation: from manufacturer to retailer

After 2014 Abercrombie moved from being an apparel manufacturer with retail operations to a pure apparel retailer. There are many signs of this transformation, like logo removal, chase inventory modality, pull modality design and merchandising, homogenization of styles, and higher marketing investment.

As a review, in most industry classifications, apparel companies are divided between retailers and manufacturers. Manufacturers focus on building an exclusive identity around the product, with operational centers in funnel-top marketing and design. Retailers focus on building an efficient retail operation, with an identity built around price positioning, and operational centers in merchandising and supply chain. Companies sit in a continuum between pure manufacturers (very common in footwear like OnOn) and pure retailers (Macy’s).

Abercrombie was already sitting at about the middle of the continuum before 2014. It had 1,000 stores but its product was super identitarian. It was impossible to miss that someone was wearing an Abercrombie or Hollister top, because of the massive logos. Further, the retail operations were also identitarian, with the famous fragrance, low lighting fixtures, and semi-naked shop assistants.

Since 2014, the company has slowly stripped many of its manufacturer traits and moved to a pure retail model. Some of these changes include:

• Homogeneization of product, starting as early as 2014 with the complete removal of logos. Today it is basically impossible to recognize that a piece is from Abercrombie because the company does almost exclusively basics that fit an open demographic of 20-40 (rightmost picture). This is very different from the collection in 2006 (leftmost, the most identitarian), and even from 2012 (center, with smaller but still existing logos and a preppier look).

  

• Chase modality in many categories. Chase is the process where inventory is sourced and replenished in a pull model, based on real-time in-season store demand. This increases product velocity but more importantly, allows to expand the number of SKUs the company can offer, therefore widening the customer-catching net. It is the core process of the fast-fashion retailer.

• Design pull-model. Accounts from the Jeffries era talk of the design function being very centralized and using a push model, trying to predict or even create product trends. Today the company says it follows customer-centric design principles, with a lot of attention paid to customer studies. This is a move from ‘offering what we believe is right to the customer’ to ‘offering what the average customer wants’.

Abercrombie has also changed its retail modality. The company is leaning much more toward DTC/e-comm, with a smaller footprint of stores that are more productive.

• Increase of e-commerce channel: In 2011 the company sold 13% of its revenue in the DTC channel, and by 2024 that figure is 45/50%.

• Decrease in-store footprint: Square footage peaked in 2011/12 at 8 million square feet and 1,000 stores (8k sqft average store). Store productivity also peaked there at $500/sqft. Today the store fleet is 5 million square feet, with 765 stores, that are smaller (6.5k sqft average, with new models in 2/4k), and more productive ($550/sqft, after removing e-commerce, $980/sqft with e-commerce).

• Decrease in employee intensity: In 2013 Abercrombie had 75 thousand employees (66k part-time) at year-end, but now has 31 thousand (25k part-time). That is half the employees per store or per dollar of sales.

A different retail structure also implies a different cost structure, with lower operational leverage:

• Increase in advertising spend. Abercrombie’s earliest reported advertising expense was $30 million in 2011, or 0.6% of that year’s sales. Today, advertising is 5% of sales. Even allowing for some reclassifications, the company is spending more on acquiring each sale.

• Increase in shipping and handling: Shipping and handling doubled from 2013/12 from about 3.5% of sales to 8% of sales.

• Lease expenses slightly reduced and de-fixed: Lease expenses are still about 9/10% of sales, but they have become a more variable component of cost. In 2012/14, lease expenses were fully fixed (minimum commitments), whereas today about 60% is fixed.

• Personnel costs decreased: Abercrombie does not disclose its personnel costs but when you remove the above costs from OpEx in 2013 you still have $1.75 billion in unexplained costs, compared to $1.35 billion today.

Differentiation in the retail model via quality positioning

The biggest advantage of the retail model is the decrease in fashion risk. The disadvantage is that lower fashion risk comes at the expense of differentiation. Here, Abercrombie’s (brand) strategy is price/quality positioning in the better/best section, with Hollister competing in good/better. This is evident when comparing the company with American competitors in social media and search.

As long as the design and merchandising functions of Abercrombie don’t sleep at the wheel, the company will not suffer a fashion headwind like 2006-2014. It should slowly follow the average trend of a slightly fashion-forward segment of young people. The problem is that, because it expresses an average, the company’s products are not recognizable per se. The cost of more stable demand is a more commoditized product that is more exposed to competition.

Guess which of the below is Abercrombie, Zara, Uniqlo, American Eagle, and Gap. If Abercrombie is suddenly on-fashion, then why is no one else growing as fast?

How to differentiate when fashion is so homogeneous? Via small changes in positioning that slightly separate each of the brands in demographics, fashion-forwardness, breadth, and especially price and quality. Some brands will be a little older or younger, sober or expressive, focused or open, and cheaper or expensive. The key word is ‘little’, brands cannot go outside of the center-average much because they would not find a sufficiently large market to sustain their retail operations.

In this case, Abercrombie’s positioning is expressive basics of better/best quality. Hollister, being a brand targeted at a younger consumer positions higher in expressiveness and lower in quality scale.

The higher pricing/quality position is also evident in the company’s historically higher gross margin. Higher positioning brands tend to have higher gross margins because the cost of quality does not go up linearly with price.

Recognition from KOLs in social media

Abercrombie & Fitch (the brand, not the company) is mentioned in fashion forums as one of the positively considered brands, whereas it is very difficult to find any other large American brand. This sustains the brand’s positioning. Hollister is much larger than peers in TikTok.

Youtube: A&F (the brand, as separate from Abercrombie the company) is positively evaluated by many influencers (Tim Dessaint, Johnny Tai), and at least evaluated by those that don’t have such positive opinions (Iron Snail, Harry Haas).

Reddit: The brand is commented in forums like r/malefashionadvice (here, here, here) and r/femalefashionadvice (here, here) (each about 6 million members) and even r/buyitforlife (here) as an impressive turnaround and considered in par with Uniqlo in terms of basics quality and above Zara.

No mention of others: There are very few if any mention in Youtube or reddit of GAP, Urban Outfitters, Anthropologie or American Eagle. Banana Republic is mentioned a little more, but not even closely as much.

Hollister is much larger on Tiktok: Being more democratic and less organized, it is more difficult to understand a conversation in Tiktok, but at least we can measure the amounts of likes each official page has. Hollister comes at 15 million, above American Eagle (7 million), Urban Outfitters (8 million), and Pull & Bear (10 million). It stands below Bershka (22 million) and Shein (75 million).

Search trends are positive for both A&F and Hollister

When we compared A&F and Hollister, each with similar competitors on search trends, we observe that both are growing faster than their peers in the US.

Valuation and scenarios

Visit and copy the napkin models here.

A simple cost model shows that Abercrombie still suffers from operational leverage, but that it has significant space to lose sales and margins before facing operating losses.

In addition, a return model shows that the breakeven scenario would be a company with 0% revenue growth, 8% operating margins and 10x P/E in 3 years, versus 14% growth and 15% operating margins today.

All of this started because Abercrombie is trading at less than 8x NTM earnings (from FY25 guidance) while growing comparables at 14% (guided for 3/5% in FY25). However, we are concerned not with today’s multiple but with scenarios of the future. That’s why I built simple models to analyze operating leverage and share returns.

Operating leverage model

As explained in the introduction, the problem of earning multiples with retailers is that operating leverage can break havoc with operating margins and earnings with little moves in revenue. In the business model changes section, I showed that Abercrombie reduced its fixed cost component via lower store footprint, lower fixed component of rent, and lower payroll expense. Still, operational leverage is a key consideration.

The first model therefore deals with operational leverage:

• We start with FY24 revenues of about $4.9 billion, and build scenarios around two sets of assumptions: sales volumes (based on CoGS) and gross margins. Gross margins is the factor that models promotionality and the inventory cycle, and CoGS models volume changes and the discretionary cycle.

• The fixed inputs are variable SD&M (4% from variable rent, 5% from marketing, 9% from shipping and handling), fixed SD&M (remaining from FY24, including $240 million in fixed rent, and undisclosed labor), and fixed G&A. This assumes no adjustment to upside or downside revenues on fixed expenses.

The scenarios show a lot of volatility around gross margins. A few percentage points of gross margin or volume change can drastically reduce earnings. this reflects the inventory and consumer discretionary cycle.

Gross margins are more critical than volumes. One percentage point of gross margin is equivalent to 5 percentage points of sales on its effect on operating leverage.

During good sales periods gross margins can reach records of 64% with operating margins of 14/15%, and during bad times closer to 58/60% with 6/8% respectively.

On the downside, the company really needs to see big headwinds (-10% sales, 58% gross margins versus 64% today) to generate operational losses.

Return models

Now, looking longer term, we need to think about average operating margins, compound growth, exit multiples, and a model of returns and cash flows.

The long-term scenarios are determined by competitive forces: can Abercrombie carve itself a space in the pure fashion retailer market, and operate efficiently enough to make a meaningful margin out of it.

The model components and assumptions:

• The two scenario variables are operating margin and revenue growth. These flow directly to net income after cash (implies no debt, as the company now has almost $1 billion in cash).

• By 2028, the shares are sold at a P/E of 10x, which I believe is a conservative estimate.

• Either net income is paid as dividends or used for repurchases at 10x P/E. These are not very realistic assumptions but making a separate cash flow model would be too complex.

• IRR is evaluated before taxes, given differences in tax treatment, and the assumption around dividends versus buybacks.

The model is very simple but does show that the breakeven scenario (red) would be basically flat growth (1%) with operating margins of 9%, with a ‘fair’ (this is always debatable) scenario of 14/16% returns at 5% growth with 11/12% operating margins, and much better returns above that growth or operating margins.

Conclusions

I started saying that my conclusions were not conclusive, and so they remain.

I think I have shown evidence of Abercrombie’s competitive differentiators in the apparel retailing space, and how these cannot be attributed to luckily riding the fashion wave. The company sells substantially the same fashion as its competitors, but grows more and makes a higher margin in two different segments of the market (premium basics and affordable teens).

The best apparel retailers, like Inditex and Uniqlo, can operate at 15/20% operating margins consistently. The average of American retailers post-GFC was closer to 10%. I think Abercrombie can sit somewhere in the middle, potentially closer to 11/12% than 14%. If that is the case, with nominal GDP growth it can meet a 15% return (obviously based on my above simplified model, reality is never so well-behaved).

All of this is to say that although the future is highly uncertain, Abercrombie has shown some meaningful differentiation and capabilities, and does not trade at an exorbitant price. The story has to be followed to see if Abercrombie can continue adapting, but it is interesting, for the time being.