Conclusion:
The tattoo that the market inked on ANF today surprised us initially, given that we saw a (modest) headline beat, bullish margin outlook, and an incremental improvement in inventories– making for one of the more positive setups in retail in 2H. Sales are off, clearly, but margins are so strong such that guidance is in-tact. Let’s face it, top line expectations for ANF are not exactly high these days – at least that was our sense. In any other week, we think that these factors would have offset much of the revenue miss.
But unfortunately, most of ANF’s sales shortfall was in Europe, and it is reporting this in conjunction with a complete Euro freak-out in the market about a bank run and potential break-up of the Euro Zone. To be clear, our Macro team (which has traded the Dollar/Euro with extreme precision over a four-year scorecard) has a strong view that this will not happen – at least not in the near future – and that we’re seeing capitulation in the Euro.
Nonetheless, most of the people that trade names like ANF are likely to get caught up in the anxiety around weakness in US tourist markets, cannibalization in Europe (the tonal change of which was new), and the company’s comments about Macro. Heck, just to get a retailer to pronounce the word Macro is hard enough. At least they have a process (inventories, costs, etc…) to deliver results in a tough climate.
When we model ANF, we get to EPS next year over $3. But today, it’s at 15x management’s EPS guidance for FY12. Clearly people who are increasingly concerned about traffic shriveling up on the vine can build to a number closer to $2. We can’t. But we can see how it can be done. Slap a low/mid teens multiple on that bad boy and you’re looking at 25% downside from here. We think that will prove to be a money-losing call over a 12-month time period. But for the next 1-2 quarters, ANF needs a catalyst to the upside to change people’s minds on the direction of earnings – otherwise it’s multiple on guidance will drift lower.
Deltas in Forward Looking Commentary?
In order to properly measure performance relative to original expectations, we look at management’s First quarter results relative to Management guidance as well as any updates to previously provided full year 2012 outlook:
Highlights from the Call
Top line Results: +10% overall
Comp: -5% with men's and women's performing comparably
US incl DTC Comp: +4%
International Comp: negative though economics remain strong (overall int'l +42%)
ANF: -4%
Kids: -11%
Hollister: -5%
Cannibalization/macro impacted international comps
Looking for strong earnings growth in 2H with peak cotton costs in the rear view
International:
Opened 7 new Hollister stores internationally including 3rd new store in China with another 2-3 planned openings
Hong Kong ANF flagship opening in August
China remains a key priority
Europe:
Opened Hamburg ANF flagship
Opening 3rd ANF in Munich later in the year
London- opened combined Hollister and Gilley Hicks store
Direct to Consumer: +40%
- International business grew faster than the overall rate of growth
- Margins remain strong
- Will drive growth through increased international awareness and investment spending
- US retail comps +4%, AUR up slightly
- Happy with Spring Merchandise
Europe performance measured based on:
- Performance relative to other stores in the mall
- Are volumes consistent with original expectations when deal was approved
- Are stores achieving annualizaed 30$ four wall margin
- Is DTC growing at a healthy rate
Gross Margin: -241bps
- Due to less promotional environment & slight better AUR
MGA: +9%
- Increase due to marketing, equity compensation
Stores and Distribution expense: +14%
- Store occupancy 179mm
EBIT Margin: -390 on 160bps of expense deleverage
Inventory: +44% above plan due to lower sales
- Have adjusted receipts for the balance of the year based on inventory
Guidance:
2Q:
- GM slightly below last year
- Modest deleverage of operating expenses
Full Year:
- Comps down MSD based on modestly positive US comp and mid teen negative international
- Greater than $250mm in revenue contribution from 2011 store openings as well as 2012 openings
- Substantial recovery in 2011 GM erosion driven by international mix benefit and AUC improvement in Fall
- FY2012 diluted EPS of $2.50-$2.75
Q&A:
Europe:
- Business was tougher than 4Q, Hollister moved from comping positive to negative
- Difficult compares in 1H
- Remain confident that stores opening today are hitting 30% four wall margin on conservative volume
- ANF is its own biggest competitor internally in Europe
- Haven't seen huge division between Northern and Southern Europe
- Expect pricing to be up slightly in the Spring and down slightly in the fall
- Pricing will be down more aggressively at ANF vs. Hollister in the Fall season
Tax rate:
- Slightly below 35% for the full year
Cannibalization
- Macro is the biggest factor in the downtrend in Europe, Cannibalization is secondary
- Now planning cannibalization into future modeling and macro environment to remain unchanged
- No impact on Hollister unit growth plan, even with cannibalization performing to plan
- Have pulled back some ANF openings due to lower economic expectations resulting from cannibalization
- Even after adjusting for cannibalization, London flagship traffic remains ahead of expectations
Inventories:
- Expect rate of growth to moderate significantly at the end of Q2
Gross Margin:
- AUR in the US business was up
- Markdowns were better than expected
Share Repurchase:
- No additional buybacks included in guidance relative to Q1
AUR:
- Hoping to raise the AUR for the balance of the year
- Flagship pricing mix has been adjusted- difficult to tell how results have changed
- Expect AUR will be raised but will respond quickly if competition is reducing pricing
Guidance:
- Had originally reduced guidance based on lower comps
- Now that comps have been reduced again, guidance is unchanged due to better than expected GM
- Big piece of the improved GM outlook is due to better AUC outlook
- Slightly higher AUR assumption
Japan:
- Doing a lot of business is Ginza however to enter the market quickly, Ginza flagship deal was uneconomical
- With better economics, the store would be more profitable
China:
- Negotiating for a flagship in China next year
- There is a lot of business to be done in China
- Pleased with start in China- need to treat china like Europe with real estate in best centers
- First store in Shanghai- good store gaining momentum
- Opened in secondary city where stores are meeting plan but less aggressive
- First store in Beijing should not have been in a 3rd rate mall, performing below expectations
- Optimistic about all brands in China
- Hollister store in Hong Kong would be rated in the top stores list
US Stores:
- Comp decline in tourist stores due to fewer tourists vs. brand issue
Consumer patterns
- Traffic is down in flagship locations which is driving volume
- Clearly see traffic down in US tourist stores
Divisional Margins
- 700bps decline in DTC margin driven primarily by YoY sourcing cost impact (rates in 2011 not sustainable, expecting mid 40s rate)
- International margin decline- big piece of decline also from sourcing with some deleveraging of expenses resulting from the negative comps
- US margins less impacted by sourcing costs- markdown taken in Q4 disproportionately benefitted Q1
Women's business
- Women's bottoms business is good
- Short business is good
AUC reductions
- Expected down DD in 2H
- Have made substantial progress with costs mostly locked
Fashion
- Continue to make progress on fashion
- The business will continue at a good rate
- Always in chase mode for fashion- good thing
- Less promotional and anticipate trend to continue
Marketing
- Being to use social media for international marketing particularly in China
- Big pushes around creating awareness with openings in China
Mobile Technology:
- Working so all online interaction is mobile and able in both the US and international
- Currently 20% of online traffic coming from mobile
Domestic Store closures:
- Planning 180 closures through 2015
- Closed 5 stores in Q1
- Will have an update later in the year after speaking with landlords
FX impact for the full year
- Will be less than the (-$50mm) full year impact provided in Feb
- Euro assumption for the full year similar to current spot rate
Gilley Hicks
- Performed well on a comp basis in the first quarter
- Very happy with the progress of the business
