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The turnaround of Abercrombie & Fitch is finally here

S&P Global Ratings on Tuesday upgraded the apparel retailer, not just on its better-than-expected 2023 performance but also its strong momentum.

The turnaround of Abercrombie & Fitch is finally here

An Abercrombie & Fitch mall store. Various analysts credit strong merchandising, inventory management and fiscal discipline for better-than-expected results at Abercrombie & Fitch Co.'s namesake and Hollister brands. Courtesy of Abercrombie & Fitch

Dive Brief:

  • S&P Global Ratings on Tuesday raised its issuer credit rating on Abercrombie & Fitch Co. to BB from BB-, citing last year’s strong sales, margin expansion, inventory management, pricing power and financial discipline.
  • “The stable outlook reflects our expectation for [Abercrombie & Fitch Co.] to maintain operating performance consistency and a conservative financial policy going forward,” S&P Global Ratings analysts Frederico Carvalho and Diya Iyer wrote in a research note.
  • Last year’s results, including “accelerated growth at better-than-expected margin,” and the ongoing momentum reflect a turnaround initiated almost 10 years ago, according to a client note earlier this month from William Blair analysts, following meetings with the retailer’s leadership.

Dive Insight:

Abercrombie & Fitch Co, which runs Hollister and its namesake brand, had a rough time moving on from its Mike Jeffries era, when it leaned on highly sexualized marketing and heavily perfumed, darkly lit stores. When the apparel retailer finally replaced Jeffries permanently in 2017, it turned to a company veteran, former chief merchant Fran Horowitz.

Those merchandising chops may be making all the difference. 

“We believe Horowitz is leading a new class of retail leaders that come from a deep merchant background, but instinctively understand the advantages that digital channels and better, broader access to data provide,” William Blair analysts Dylan Carden and Alexander Vasti wrote. “Further, they believe that the business should be operated not from a position of fear of losing a sale, but overall inventory yield and focus on longer-lasting, deeper customer relationships.”

That gives the retailer momentum as it marches toward its longer-term goal of $5 billion in global sales, as reiterated by Horowitz in March. For the year, the company reported 16% year-over-year net sales growth, reaching $4.3 billion, as comps rose 13% and gross margin expanded by 600 basis points to 62.9%.

The S&P Global Ratings “upgrade reflects Abercrombie & Fitch Co.’s … revenue increase and higher operating margins despite the challenging macroeconomic backdrop,” Carvalho and Iyer said, noting that the full-year revenue growth was due to higher average unit retail expansion and improved customer traffic, which was ahead of their expectations. 

“While many mall-based retailers are struggling to revive positive sales, we expect revenue expansion will continue this year as [Abercrombie & Fitch Co.’s] main brands continue to resonate with customers,” they also said. “The Hollister brand, which has fallen behind in the past, responded to the company’s transformation initiatives implemented in 2022 with sales increasing 6% in 2023 compared to a 9% decline in the previous year. At the same time, the Abercrombie & Fitch brand maintained strong growth momentum and ended last year with comparable sales growth of 23%.”

The S&P analysts also credit the company’s merchandising, noting that “strong demand for the company’s products reflects the repositioning of its main brands, new assortment that includes activewear and wedding dresses, new in-store experiences and enhanced marketing spending.”

The company last month unveiled “The A&F Wedding Shop,” with assortments for brides, bachelorettes and wedding guests.

S&P’s Carvalho and Iyer said they expect both brands to continue to grow, “with revenue expanding about 6% this year largely based on the company’s ability to attract and retain new customers” but moderating to closer to 4% next year. Financial and inventory discipline will help the retailer sustain its operational momentum, keep its focus on profitable growth and overcome challenges like troubles in the Red Sea (which “will impair the company’s European, Middle Eastern, and African (EMEA) operations and offset further international freight gains”), according to S&P.

Operational discipline will also pay off this year and beyond, those analysts also said, adding that they “anticipate disciplined inventory management to persist,” enabling what they say could be further adjusted operating margin expansion of 70 basis points this year and flat in 2025.

“We also expect a more efficient integration of the company’s omnichannels, which resulted in store productivity per square foot increasing 18% since 2019,” S&P said. “This will contribute to sustained operating performance going forward.” 

Higher operating margins helped lower Abercrombie’s S&P Global Ratings-adjusted leverage in 2023, and “strong [free operating cash flow] generation supported debt reduction of about $77 million and an increase of cash balance to $901 million,” the analysts said, adding that they expect the retailer to refinance its $350 million senior secured notes due next year.

“We believe the company’s significant credit metrics headroom and elevated cash balance provide it with financial flexibility to continue to implement its transformation plan, invest in its business, and pursuit growth opportunities,” the analysts said.

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