Is the End of Teen Retail Nigh?

 | Feb 03, 2012 | 2:00 PM EST
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On Thursday, Abercrombie & Fitch (ANF) preannounced dismal fourth-quarter earnings results. The company said same-store sales were flat and that gross margins dropped a frightening 750 basis points (bps), driven by aggressive markdowns. Although sales rose 16%, it was not enough to overcome the onslaught of holiday bargain hunters rummaging through the racks.

This raises the question: Is this the final nail in the coffin of teen retail or will these types of stocks bounce back once consumers feel more confident?

The company said sales for the quarter ending Jan. 29 would come in below Street expectations. For the quarter, management told investor to expect a per-share earnings of $1.10-$1.15, vs. expectations of $1.54. The company also offered to forecast the rest of fiscal 2012. It said earnings per share for FY12 would be in the range of $3.50 to $3.75 based on the assumption of an entire year of flat same store sales. (For fiscal year 2012, most investors were expecting same-store sales would be up in the 8% to 10% range.) Yuck!

In after-hours trading, the stock got wrecked. For those who want to see the full damage, the company will formally announce earnings on Feb. 15. (How's that for a Valentine's Day gift?)

The preannouncement sent investors back to their spreadsheets. Sales for fiscal year 2012 and fiscal year 2013 were expected to be about $4.2 billion and $4.9 billion, respectively. But now those forecasts seem overly optimistic, especially since the company has focused on international expansion to bring in the big bucks. Abercrombie plans to open four to five flagship stores overseas and plans another 40 Hollister mall locations in the U.S. In addition, the company has plans to shut 55-60 U.S. stores when their leases expire.

But all of these projections are based on operating margin expansion. For example, investors were thinking the company would be able to squeeze out another 90 basis points in operating margin in fiscal year 2012 (to 9.1%) and find another couple of basis points from price increases and favorable sales mix. But that's gone out the window. A 750-basis-point hit to gross margins during the crucial holiday season really tossed everything up in the air. During the October quarter, the company said business slowed throughout Europe and some flagship stores even had negative same store sales. Japan and Canada are "challenged" and "economic headwinds" have turned U.S. teens into bargain hunting machines.

But Abercrombie isn't the only retailer hurting right now as once red-hot Urban Outfitters (URBN) has been having its own troubles. At last count, the company's inventory was up 27% and the company was desperately trying to blow out its stock of slow-moving garb. In the third quarter, Urban had to take a 571-basis-point hit to gross margins just to lure teens into the store. Back in October, management told investors to brace for lower gross margins in the fourth quarter. Holy cow.

Three years ago, no one would have ever thought these two companies would be having this kind of trouble. Turns out they are not invincible after all.

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